professional about the possibility of combining all your debts into one loan with a lower interest rate. Investigate different solutions. It is also important if you have student loans to be cognizant of your payment dates and obligations. Your credit score is an important element to obtaining a mortgage.
2.2 Understanding the difference between pre-qualify and pre-approval
Many buyers use the terms mortgage pre-qualify and mortgage pre-approval interchangeably. Many people believe they mean the same thing but this is not the case.
To be pre-qualified, you simply get an estimate of how much of a mortgage you will likely be able to qualify for based on current interest rates — a credit check and verification of employment have not been completed. During a pre-qualification meeting you present to the lender details of your income, expenses, assets, and liabilities to determine how much of a mortgage for which you will likely qualify.
A pre-approved mortgage is a formal application process. During the process you will be asked for information regarding your finances and creditworthiness — a credit check will be completed and your income will be verified. The lender or mortgage professional will use several factors, such as your income amount, credit score, employment records, and the amount of down payment you have, as guidelines to determine how much of a mortgage it will pre-approve for you. The lender will request a list of items including, but not limited to the following:
• A list of all your assets (e.g., vehicles, savings accounts, stocks, RRSPs, and GICs) along with an estimate of each asset’s value.
• A list of all your liabilities (e.g., vehicle loans, credit cards, student loans) along with the balance owed for each.
• A letter from your employer confirming your employment including your income, position, and number of years with the company. Sometimes the lender may also request copies of T4 slips for the past couple of years. If you are self-employed you will need to provide notices of assessment and possibly tax returns and/or financial statements for the last two or three years, depending on the lender.
• Source of down payment funds. The lender will want to verify where the funds are coming from. If the down payment is being provided by family members, the lender may ask for a letter confirming the funds are a “gift” and do not need to be paid back.
• Personal information (i.e., social insurance number, as well as a source of photo identification such as a driver’s licence or passport).
Remember, if you are applying for a pre-approved mortgage with a spouse, family member, or friend, all parties will be required to provide the above information.
Assuming everything checks out, you should be given a written mortgage pre-approval outlining the amount that the lender will commit to over a specific time frame and at what interest rate. The mortgage pre-approval may also specify certain conditions, so make sure that you understand the terms and conditions of the pre-approval. Special conditions and requirements may include that you pay off a credit card or debt.
The guaranteed lock-in time frame is an important date to keep in mind when searching for a home. This is a cut-off date or time frame for which your interest rate is guaranteed. Beyond that time frame, if interest rates have increased, you may find that it could affect what you are approved to spend and the cost could be higher. The guaranteed lock-in time frame is usually three or four months depending on the lender. Most of the time, buyers have no problem finding and closing on a home within this time frame. (If you are considering purchasing a new home that is not yet built with a longer anticipated closing date, check with the builder and your lender because often there are mortgage products or programs designed for new construction purchases.)
If interest rates decline, you should get the benefit of the lower rate. Check with the lender or mortgage professional about this, and where possible, get this in writing.
Having the interest rate locked in is one of the advantages of getting a pre-approved mortgage (versus a pre-qualified mortgage). Another benefit is that a pre-approved mortgage gives you leverage during the negotiations of your home purchase, which could turn out to be a competitive advantage in a hot real estate market.
With a pre-approved mortgage, some buyers consider making an offer to purchase a home without a finance condition; keep in mind that your lender will still want to have the property appraised to ensure you are paying a fair price. Additionally, if you are borrowing greater than 80 percent of the appraised value of the property, your lender will want CMHC or Genworth Financial Canada (or another high-ratio insurance company) to approve the transaction.
If the appraisal is for less than the purchase price, this could become a problem, and you may not be approved. Many buyers opt to include a short-term (i.e., one or two business days) finance condition to ensure that the appropriate property appraisals and insurance confirmations are obtained. This is a conservative and prudent strategy to ensure that everything is approved.
Speak with your mortgage professional about specific requirements. Don’t assume just because you have a pre-approved mortgage that the property is approved for the mortgage. You want to be certain that you obtain written approval from the lender that your mortgage loan is approved before you waive or remove your finance condition.
2.3 Determine how much you can spend on a home
Lenders generally use two basic guidelines to determine how much they will lend you: Gross Debt Service Ratio (GDS) and Total Debt Service Ratio (TDS).
The Gross Debt Service Ratio (GDS) is where 32 percent (according to www.cmhc.ca, accessed October, 2011) of your gross income is used to determine what you qualify to pay for mortgage principal, interest, property tax, and heating per month (check with your lender or mortgage broker to confirm what you should use for the heating cost). In the case of condominium properties (e.g., apartment, townhouse, or other), you need also to factor 50 percent of the monthly maintenance fee into your calculation.
Figure out what 32 percent of your income is. For example, 32 percent of an annual income of $50,000 equals $16,000. Divide $16,000 by 12 which equals $1,333 per month.
a) Annual income $________ x 0.32 = $ _______________ divided by 12 = $_____________ (principal; interest; tax; and heating per month; plus 50 percent of monthly condo fee, if applicable)
The Total Debt Service Ratio (TDS) is where 40 percent of your income is used to determine what you qualify to pay for above housing-related expenses plus all other loans (e.g., vehicle loans and credit cards). For example, an annual income of $50,000 x 0.40 equals $20,000. Divide $20,000 by 12 which equals $1,666 per month.
b) Annual income $________ x 0.40 = $ _______________ divided by 12 = $_____________ (principal; interest; tax; heating per month; 50 percent of monthly condo fee, if applicable; plus other loans)
Property taxes and heat along with the mortgage payment (and condo fees, if applicable) are used to ensure the borrower can afford the home at the minimum standards of living, based on the essential shelter costs of the property. The mortgage payment (principal and interest) are a given that the borrower must be able to afford; however, property tax is also important as default can result in action by the city or municipality. Property tax liens have priority over the first mortgage. Monthly condominium/maintenance fees also take precedence over a mortgage. Depending on whether or not the utilities of a given municipality are privatized or municipally owned, it is also possible that default of payment on utilities can result in a lien against the property that may take precedence over the mortgage. If the local utilities are municipally owned, this would
