Mortgage Information & Pre-Approvals

The first step in the home-buying process is to determine how much you can afford to spend. In this section we are going to review the mortgage pre-approval process and how lenders determine the amount you are qualified to borrow.

What is a Mortgage?

A mortgage is a loan provided by a lender, such as a bank or mortgage lending institution, that helps you finance the purchase of a home. The mortgage contract is registered against the property, and the property serves as collateral for the loan. Mortgages are typically paid back over a set period, with interest.

Types of Mortgages

Fixed Rate Mortgages: The interest rate remains the same throughout the term of the loan, leading to consistent payment amounts. This type of mortgage is ideal for those who prefer stability in their monthly budgeting.

Variable Rate Mortgages: The interest rate can fluctuate based on market conditions. This means your monthly payments can go up or down. This option might offer lower initial rates compared to fixed-rate mortgages.

Conventional Mortgages: Requires a down-payment of 20% of the property's purchase price.

High-Ratio Mortgages: If your down-payment is less than 20%, you'll need a high-ratio mortgage, which requires mortgage loan insurance.

Down-Payments & Mortgage Insurance

The minimum down-payment in Alberta depends on the home's purchase price. For homes less than $500,000, the minimum down-payment is 5%. For homes between $500,000 and $1 million, it's 5% for the first $500,000 and 10% for the remaining amount. Properties over $1M require a 20% down-payment.

These minimums are set out by CMHC (the Canadian Mortgage and Housing Corporation). CMHC is a wholly-owned crown corporation that helps inform the government about the housing market, and provides financing and other housing solutions to the market.

One way that CMHC helps provide financing to consumers is mortgage insurance. Mortgage insurance is insurance for the lender, so that in the event of a default by the borrower, the lender is still paid-out the value of the loan. This allows people to access mortgage capital that they may not otherwise qualify for. As an example, if you were to purchase a $500,000 home, the mortgage lender may require 20%, or $100,000, as a down-payment. With CMHC willing to insure the lender against potential losses due to default, the lender will now only require the CMHC minimum down-payment of 5%. Allowing you to purchase your $500,000 home with a down-payment of only $25,000.

This mortgage insurance is not free. Like other insurance, you pay a premium to acquire the insurance. CMHC premiums are paid up-front and added to your total mortgage amount outstanding, at the time you take your mortgage. Insurance is required for high-ratio mortgages, and the premium depends on the percentage amount of down-payment you put down. At 5% down the premium is higher than at 10% down, which is higher still than the premium at 15% down, and so on. 20% down and above does not require mortgage insurance, and is what's called a conventional mortgage.

Benefits of a Mortgage Pre-Approval

A mortgage pre-approval is an in-depth assessment of your financial situation by a mortgage broker or specialist, which provides you with an estimate of the amount of money you would be able to borrow to purchase a home. Typically, a mortgage pre-approval also comes with an interest rate hold that is guaranteed for (most often) 90-120 days. During this time, if rates rise, you retain the lower interest rate, but if rates fall you still receive the new lower interest rate.

Having a mortgage pre-approval in place gives you an edge when negotiating in tight markets. While you don't have to show sellers your actual pre-approval or disclose any personal information, your Realtor can confirm and verify to the Listing Agent on your behalf that they have seen and qualified the pre-approval, giving sellers peace of mind that the deal will not get unnecessarily hung up on financing. 

A mortgage pre-approval also speeds up the closing process, which benefits you not only if you would like to make a quick move, but with shorter condition dates on your offer. This means less time for the seller's property to be "tied-up" while they wait to find out if the deal goes through or not. That shorter time period for them, where their property is "pending", makes your offer more attractive compared to others.

How to Get a Mortgage Pre-Approval

You can obtain a mortgage pre-approval directly from your bank, or through a Mortgage Broker. Brokers can offer you mortgages from various lenders and may be able to help you find a better rate or terms.

Your bank representative, or Mortgage Broker, will help you assemble all the required documentation, and review them with you before submitting them for the pre-approval. They can also help explain the criteria that lenders will review before approving the application. An overview is provided below.

Debt Ratios

Lenders determine how much you are qualified to borrow by applying two debt ratios:

Gross Debt Service Ratio

and

Total Debt Service Ratio

Gross Debt Service Ratio: is calculated by dividing housing costs (mortgage principal+interest, property tax, utilities, 50% of condo fees if applicable) by your income.

Total Debt Service Ratio: is calculated by dividing your housing costs noted above, plus any other debt obligations, by your income. Other debt obligations may include car loans, student loans, and any other secured or unsecured credit.

The maximum GDS and TDS ratio limits for borrowing will depend on the lender you use for your financing. Major Canadian banks will allow a GDS not exceeding 32% and a TDS not exceeding 40% for conventional mortgages, while a GDS not exceeding 39% and a TDS not exceeding 44% are acceptable for CMHC insured mortgages. Secondary and private lenders set their own limits on the debt service ratios they allow.

Knowing the GDS and TDS limits your lender will allow, your maximum monthly payment can then be calculated which, subsequently, can be used to calculate the maximum amount you may borrow. When added to your available down-payment amount, we arrive at your maximum possible purchase price.

Checks & Verification

When you go through the mortgage pre-approval process, the lender is assessing your financial health and determining the maximum loan amount they are willing to offer you. This process involves a thorough review of your income, credit history, employment status, and overall financial health. Here's what you can expect:

Credit Check: The lender will perform a credit check to assess your credit score and credit history. A higher credit score will help you qualify for better interest rates and loan terms.

Income Verification: You will need to provide proof of income, such as pay stubs or a letter from your employer. This helps the lender ensure that you have a stable income and can afford the mortgage payments.

Tax History: Most often, lenders will want to see your previous two years of tax returns, to confirm that you have earned the amount of money that you claimed to have earned. If you are self-employed, they may want to see 3+ years of returns.

Debt-to-Income Ratio: As discussed, lenders use the Gross Debt Service (GDS) and Total Debt Service (TDS) Ratios to evaluate how much of your income goes towards housing costs and overall debt. They use these ratios to determine how much you can borrow without overextending yourself financially.

Down-Payment Requirements: The size of your down-payment can significantly impact your mortgage terms. A larger down-payment typically means a smaller loan amount, lower monthly payments, and possibly a better interest rate. In Alberta, a down-payment of at least 5% of the home's purchase price is required, with 20% being the threshold to avoid needing mortgage insurance. 

In some cases, mortgage insurance can actually help you attain a lower interest rate than what you could achieve with a conventional mortgage. However, depending on the amount that you put down as a down-payment, the insurance premiums could end up costing you more than you save from the lower interest rate over the term of the mortgage.

Interest Rate & Rate-Hold: Your pre-approval will include an interest rate hold, which is typically valid for 90-120 days. This rate hold protects you from rate increases during this period, though you can still take advantage of lower rates if they drop.

What to Watch Out For

While mortgage pre-approvals are incredibly useful, there are a few things to keep in mind:

Validity Period: Remember that the pre-approval is only valid for a limited time, usually 90-120 days. If you don't find a home within that period, you may need to go through the process again.

Changes in Financial Situation: The pre-approval is based on your current financial situation. If your income decreases, you take on new debt, or your credit score drops before you finalize your mortgage, your lender may reassess your eligibility.

Some people make the mistake of thinking a pre-approval is a "promise to loan", so they get their pre-approval and then go out and buy a car, for example, before closing on their home purchase. The bank will pull a new credit check and re-check the GDS and TDS debt ratios before issuing the mortgage. If you have new debt at that time, that you did not have during your pre-approval, your mortgage approval might be jeopardized. Your best bet is to be cautious and not make any debt-based purchases between the time of your pre-approval and your home purchase, without first speaking with your lender to find out if you will still qualify.

Not a Guaranteed Approval: While your pre-approval is a strong indicator you will be approved for your mortgage, it is not a guarantee. The pre-approval is the bank saying, "based on your income, debt, and credit rating, we will loan you this amount and this rate." However, they still need to approve the property you are borrowing against and the value that you are paying for it. 

For example, they will not lend you $300,000 against a home they value at $200,000, even if you qualify to borrow $300,000.

Basically, they have qualified you as a borrower, but they still need to qualify the property you are purchasing. For this reason, you should NEVER make an offer that is not subject to financing, unless you are able to pay for the home in cash. If you are using mortgage funding to pay for the home, be sure to include a "subject to financing" condition. Your Realtor can help you with this.

Conclusion

The mortgage pre-approval process is a vital first step in the home-buying journey, providing you with a clear understanding of your budget, protecting you against interest rate hikes, and strengthening your position as a buyer. By understanding how lenders determine your borrowing capacity and the importance of debt service ratios, you can approach the home-buying process with full confidence.

Remember, a pre-approval is not just about knowing how much you can borrow - it's about setting yourself up for success in finding and financing your new home! If you're ready to start this important step, reach out to a trusted Mortgage Broker or bank representative to begin the pre-approval process today! If you don't have a Mortgage Broker or bank representative that you know and trust, your Realtor can help you with a connection to a respected mortgage professional.