Preface: As most readers know I take a dim view on Guest Posts, however Sean Cooper is a friend of this site, and this content is topical.
Imagine this: after weeks and weeks of house hunting, you finally find the “one,” your dream home. You make and offer and it’s miraculously accepted. Congrats, you’re finally able to call yourself a homeowner! Well, almost. Unless you’re able to pay for your home in cash (can you adopt me?), you’ll have to take out a mortgage. If you’ve never applied for a mortgage before, you’re probably wondering how the process works (unfortunately, they don’t touch this stuff in school).
Let’s look at the four main factors lenders look at to qualify you for a mortgage and why.
1. Your Income
A mortgage is a lot of dough, even for banks. Lenders won’t just approve anyone for a mortgage. The banks are looking for someone earning a steady paycheque over at least the last couple years (someone who’s a salaried employee). If you’re a self-employed or contract employee, you’ll have a lot tougher of a time qualifying for a mortgage. (Although a talented mortgage broker can help you find a lender well suited to you.) The reason for this is simple. The banks only want to lend to someone who will be able to afford to consistently pay their mortgage.
However, there are things you can do to help qualify for a bigger mortgage if you’re buying in a pricey real estate market like Toronto or Vancouver. By earning more income, you can qualify for a bigger mortgage and afford a more expensive home (all things considered equal).
If you aren’t able to qualify for the mortgage you were hoping, you might want to consider applying for a mortgage with a partner. It doesn’t have to be your romantic partner, it could be a brother, sister, aunt or uncle. If you have two incomes when applying for a mortgage, it will be a lot easier to get it approved to buy your dream home.
2. Your Down Payment
Similar to your income, the larger your down payment, the easier it will be to qualify for a mortgage. Ideally, we could all afford to make a 20 percent down payment, but that’s just not realistic, especially in cities like Toronto. Even putting 10 percent down can be challenging in pricey markets. Your down payment matters to lenders because they want to know that you have skin in the game.
If you’re unable to save up 20 percent towards your down payment, aim for a minimum of 10 percent. Besides, if you’re buying a home for under $1 million, you’ll be required to put at least 10 percent down on your portion of the sales price between $500,000 and $999,999. By putting more than 5 percent down, your mortgage will be smaller, helping you save on mortgage interest over the life of your mortgage.
But coming up with a larger down payment is easier said than done. How can you do this? By boosting your income or cutting back on expenses. To earn extra income, you could start your own business in your spare time. For example, if you’re skilled at photography, you could become a wedding photographer. Ways to save on expenses include carpooling and taking public transit more often and brown-bagging your lunch. If you could save yourself $50 a month extra, that’s more money you could put towards your down payment.
3. How Much Debt You’re Carrying
Besides how much money you make and your down payment size, lenders also care about how much debt you’re carrying. The reason is simple: the more debt you’re carrying (car loans, credit card, student debt, etc.), the tougher it makes it to make your mortgage payments on time and in full should you run into financial difficulties, such as job loss.
The banks use two main debt ratios when qualifying you for a mortgage: the gross debt service ratio and total debt service ratio. Most lenders require you to meet the minimum debt ratios to qualify for a mortgage. At times lenders may be willing to waive one of the debt ratios, but it’s at their discretion. For instance, they may only be willing do it if your other factors are strong (you’re earning a high salary and you have a decent sized down payment).
4. Your Credit
The last factor lenders look at when qualifying you for a mortgage is your credit. Banks review your credit in a couple ways: your credit score and credit report. The credit bureaus Equifax and TransUnion assign individuals a three digit number as your credit score. Credit scores typically range from 300 to 900. (It’s better to have a higher credit score than it is to have a lower credit score.) Lenders are looking for a credit score of 700 or higher. Your credit score matters to lenders because it indicates how likely you are to repay your mortgage and other debt.
A decent credit score can be a huge asset. It shows that you are able to use credit in a responsible manner. (You pay your bills on time and in full.) It can also help you qualify for a mortgage with the big banks and other well-known lenders and obtain the best mortgage rate. If your credit score is below 700, you may have to pay a higher mortgage rate or your application could be turned down.
To make sure your credit is in good shape, it’s a good idea to look at your credit score and credit report at least once every six months. You’ll especially want to review it before applying for a mortgage. If there are any issues, you can hopefully get them resolved before you apply for a mortgage.
Disclaimer: Contact a mortgage professional to see if the strategies mentioned apply to your specific situation.
This post was written by Sean Cooper, bestselling author of the book, Burn Your Mortgage. Sean is also the managing editor ofmortgagepal.ca.