Before you start the house-hunting process, there’s an important step you can take to save you time and make the process smoother: getting pre-approved for a mortgage. A pre-approval determines the home price you can afford which allows you to budget for your home purchase and focuses your home search. With a pre-approval you’ll also be able to lock in a mortgage rate in case rates increase during your home search.
What is a Mortgage Pre-approval?
A mortgage pre-approval is a process that provides you with important information to help you with your home search. When you get pre-approved for a mortgage, you’ll find out:
- The maximum amount you can afford to spend on a home
- The monthly mortgage payment associated with your maximum purchase price
- What your mortgage rate will be for your first mortgage term
Applying for a mortgage pre-approval is free and it doesn’t commit you to one single lender. However, getting pre-approved does guarantee that the mortgage rate you are offered by a lender will not change for 120 to 160 days. By “locking in” your rate, you’re protected if interest rates rise while you’re shopping for a home. If interest rates go down during this time, your lender will honour the lower rate.
Why Get Pre-approved for a Mortgage
Getting pre-approved for a mortgage helps you in several ways: It saves time in your home search because you’ll only look at homes in your price range. Getting pre-approved is also a signal to your real estate agent that you’re serious about buying, and you’ll receive faster more targeted service. Finally, when it comes time to make an offer on a home, the fact that you are pre-approved signals to the seller that you should have no problem financing the purchase, which will improve your chances in a competitive offer situation. Don’t forget that if interest rates fall while you are locked in, your lender will honour the lower rate.
How to Get Pre-approved for a Mortgage
To get pre-approved, you must meet with either a mortgage broker or a lender. To determine how much you can afford to borrow to purchase a home, they will ask you a series of questions and you will need to provide some supporting documentation.
Your credit score is a measure of your financial health, and shows lenders how risky it may be to lend you money. If your credit score is between 600 and 900, you’ll likely qualify for a mortgage with an “A” level lender, such as a major bank.
However, if your credit score is below 630 and above 600, lenders will look at the other details of your finances to determine if you can qualify with an “A” level lender or not. If you don’t qualify, you’ll need to go through a “B” level lender, such as Home Trust, to get a mortgage pre-approval.
If your credit score is below 600, you will only qualify for a mortgage with a “B” level lender, and you won’t get today’s best mortgage rates.
Your down payment is the lump sum of money you’ll put towards the purchase of your home. In Canada, the minimum down payment you must make is 5% of the home’s purchase price. If you put down less than 20%, you’ll have to buy mortgage default insurance to protect your lender in case you default on your loan.
The size of your down payment affects how much you can borrow. For example, if you wanted to buy a house worth $300,000, you would need at least a $15,000 down payment.
$300,000 x 5% = $15,000
As of February 15th 2016, the minimum down payment is higher for homes sold for $500,000 – $999,999. You now need to put down 5% of the first $500,000, and 10% of any amount over $500,000. For example, a house worth $600,000 would require a down payment of at least $35,000.
($500,000 x 5% = $25,000) + ($100,000 x 10% = $10,000) = $35,000
Debt Service Ratios
Your debt service ratios are two calculations that lenders use to determine the largest monthly mortgage payment you can afford, based on your current monthly income, expenses and debt. Lenders use these ratios to make sure you can afford to make your monthly mortgage payments, even with all of your other financial commitments, so there’s a smaller risk that you could default on your mortgage payments.
Depending on the mortgage broker or lender you sit down with, the documentation you’ll need to submit for your pre-approval may vary. For example, some mortgage brokers require proof of income for a pre-approval, while others don’t require proof until your offer has been accepted and you need to finalize your mortgage application.
Here is a list of documentation you may need to provide for your mortgage pre-approval:
- Proof of income (pay stubs and letter from your employer, or a notice of assessment if you are self-employed)
- Length of time with employer
- Proof of down payment and ability to pay closing costs (recent financial statements of bank accounts and investments)
- Proof of any other assets like a car, cottage or boat
- Information about other debts including:
- Credit cards or lines of credit
- Spousal or child support payments
- Student loans
- Car leases or loans
- Personal loans
After You Receive a Mortgage Pre-approval
Once you’ve been pre-approved, you’ll know the maximum amount you can afford to borrow, as well as the mortgage rate lenders are willing to offer you. If you lock in that interest rate, you’ll be protected from future interest rate increases for the next 120 to 160 days while you search for a home. You can then take the maximum mortgage amount and use it as a guide during your house-hunt, so you only view homes you know you can afford to buy.
The Limitations of a Mortgage Pre-approval
One thing to keep in mind is that getting pre-approved for a mortgage doesn’t guarantee that your final mortgage application will be approved. When you apply for a mortgage after your Offer to Purchase has been accepted, your lender will look at the details of the property to make sure it’s suitable. If the property doesn’t meet their qualification criteria, you won’t qualify for a mortgage. For example, if the home has asbestos, knob and tube wiring, is a heritage home, or its appraised value is below the purchase price, the lender may not find it suitable and could deny you a mortgage.
Getting pre-approved for a mortgage also doesn’t mean that you should buy a home at the top of your price range. Your pre-approval amount only represents how much your lender is willing to lend you, not how much you should spend. You can choose to buy a home that is priced lower than your maximum purchase price which will ensure you have enough room in your budget for saving and paying down debt.