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Complete Mortgage Guide for First-Time Home Buyer
Welcome to this complete guide to applying for your first mortgage
This guide aims to help you get a foundational understanding about mortgage, and the application process.
What you should know about applying for your first mortgage:
- Lender (banks) review your profile to determine that you have the ability to pay back your mortgage.
- Your profile must proves that you have income stability, good credit score, and certain debt to service ratio.
- All of this is to reduce the risk of the lender. They do not want to lend to someone that might default on the mortgage.
1. Income Stability
Lender will look at your source of income to determine your income stability. They’ll often request a few months of paystubs, a letter of employment, and bank statements showing that you’re being paid from this employer.
Lender then use the above income to calculate your “gross and total debt service ratio”, or GDS.
GDS focuses on home related expenses, and is a ratio of your total income. For example, if all expenses of your home made up 40% of your total gross income. The GDS ratio is 40%.
These expenses are what mortgage professionals call PITH:
- Principal & Interest payment (PI)
- Property Tax (T)
- Heating & Utilities (H)
The second ratio that lenders calculate is “Total Debt Service Ratio” or TDS. TDS includes other debts beyond your PITH like car loans, student loan, or any owed credit card amounts. Your TDS has to be lower than 44% in most cases for lenders to qualify you for a mortgage.
Stress Test for Mortgage
Stress test for mortgage was introduced in 2018 to ensure home buyers can still afford monthly payments if interest rate was increased.
Stress testing include adding 2% to your approved interest rate with a certain lender and checking if your GDS and TDS ratio above still meet requirements.
If the above method of adding 2% to your approved rate is still under 5.25%, then the benchmark rate of 5.25% is used.
2. Credit Score Review
Most lenders will perform a credit check and review your credit history.
Higher score indicates to lenders that you have been responsible with your money. This gives you a higher chance of getting an approval. Most often, higher credit score will also give you a lower interest rate because lender wants you as a client.
An average Canadian credit score is about 750. So if your score is within this range, you’ll easily qualify for a mortgage. If your score is under 650, there might be a chance you’ll get declines from lenders and might have to look for alternative lenders.
3. Type of Lenders
Beyond your typical banks, which are called A Lenders, there are also other credit unions and private lenders. They are divided into 3 categories:
A Lenders: most major banks (Scotiabank, BMO, RBC, etc…). They are the safest choice and often offer competitive rates. However, their requirements will also be strictest because they want to ensure minimal risks.
B Lenders: Some smaller banks and credit unions are classified as B lenders. Their requirements on income are less stringent as they need customers. However, interest rate from B lenders are often higher to make up for their lower requirements on income.
C Lenders/Private Lenders: As the name suggest, these are private lending company or group of investors that are willing to take on riskier clients. However, their interest rate is often much higher to compensate for the risk. Private lending rates are often double that of A lenders’ rate or higher.
4. Understand Mortgage Terminologies
Below are some mortgage basics you need to know as first time home buyers:
1. You can get a mortgage pre-approval before starting to look at houses.
Banks will provide pre-approval up to acertain amount. Coupled with your down-payment, you’ll know exactly how much you can afford. This make house hunting much easier.
As an example:
You and your partner’s combined income is $100,000, and you have $150, 000 in saving. Banks often offer a mortgage somewhere in the range of 5-6x multiple of your income depending on the program. Which means you can borrow up to $500-600,000. Coupled with your saving of $150,000, you can afford a home up to $750,000.
2. Fixed rate mortgage means the interest rate you pay across your mortgage term is fixed.
Eg. Fixed 2% on a 5 years term.
3. Variable rate mortage means that the interest rate fluctuates based on the prime rate that the Bank of Canada sets out.
This can change over the term of your mortage.
Eg. 1.5% variable rate can increase to 2% in the next year, and again to 2.5% the year after, but decrease to 2.15% in the final 2 years.
4. Amortization period is the total time that it will take topay off your whole mortgage in full.
Often set at 25 or 30 years. With a 30 years amortization, your monthly amount can be smaller.
5. Mortgage appraisal happens after you signed an agreement of purchase and sale. The bank will appraise the property to ensure that the loan they give out match a property value. Anything higher is your responsibility to pay.
It is worth while to speak with a mortgage professional to understand your finances and prepare for this major purchase.
The difference between a mortgage broker vs. a mortgage specialist
Mortgage broker often works for third party agency and can work with multiple banks to get you a mortgage.
A mortgage specialist is a dedicated specialist of a certain bank (think TD, Scotiabank, BMO, CIBC, etc…). They can only offer mortgage programs from that bank.
Both are good professionals to engage to understand your finances and discover programs that work for you.
5. How the Mortgage Approval Process Works
After engaging a mortgage specialist or broker, they would often ask basic questions about your income & job as well as your real estate needs.
Next, they will ask you to submit documentations to start the process, either as a preapproval, or a draft application.
A preapproval ensures that there’s a cap for your affordability and help you & your real estate agent to set boundaries when reviewing homes.
Becareful that too many preapprovals will negatively impact your credit score (each request into your credit history will lower the score).
After offering to buy, and accepted, the lender will review your entire application with true data on that home (mortgage amount, taxes, heating/cooling estimates, etc…).
If approved, they will send you an approval letter to sign. This approval letter will outline the rate, conditions and length of the mortgage. Make sure to read and understand the documents along with all conditions before you sign.
Before closing, your lawyer will review this and connect with the lender to receive the mortgage funding. This will get transfer over to the Seller’s lawyer on closing day to complete the buying process.
6. Things to Remember
1. As lenders often make final checks before releasing the mortgage funding to ensure that you still have the same job and income source, do not make any job change within the last month of the closing period.
If you intend to do so, besure to communicate it to your mortgage specialist to ensure that there are strategies in place to obtain the mortgage.
2. Do not make major purchases closer to the closing date, such as an automobile or renovations. If you apply for a loan, your credit score will be impacted along with your GDS and TDS score.
Lenders will have to reassess your application and you might fail the stress test based on new ratios.
3. Communicate any major financial changes to your mortgage specialist. They are your trusted advisor. They work for you to ensure you receive a mortgage. If you don’t diclose information to them, they can’t do their job effectively.
The mortgage process is complex and requires many steps. Having a complete understanding of how lenders assess your application is essential.
If there are areas that need improvement, like income, credit score, downpayment and preapproval, don’t hesitate to ask questions. An experienced mortgage specialist will often have contigency plans to help you fix the issue before it’s too late.