Your First Home. Kimberley Marr
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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 be the case. If they are privately owned, the company will send it to collections. This is essentially why a lender includes property tax, heating, and 50 percent of the monthly condo fee (if applicable) into the calculations to determine what the borrower qualifies to spend.
These ratios are general guidelines that lenders use to qualify and pre-approve you for a mortgage. However, some lenders are willing to approve a conventional borrower with a credit score of 680 or higher using a 44 percent TDS ratio. If you have 20 percent or more for a down payment, you are considered a conventional borrower and there will not be an insurance premium in most circumstances. Understand that a combination of your credit score, the amount of your down payment, and your employment are used to confirm and approve your mortgage loan. Again, lenders may have some discretion to slightly modify the ratios if you are a conventional borrower with a 680 or higher credit score. Speak to your mortgage professional regarding your individual mortgage situation.
Be careful about purchasing a vehicle, participating in long-term “don’t pay” events for furniture or appliances, or incurring any other indebtedness because it may affect your TDS ratio. Always be aware of how borrowing will affect your credit score.
To finalize the maximum purchase price that you are able to spend you need to determine how much of a down payment you have, with 5 percent of the purchase price being a minimum amount. Again, if you have less than 20 percent down payment, you are considered a high-ratio borrower, and you will likely be required to obtain mortgage default insurance (also called mortgage loan insurance), which you will get from either CMHC or Genworth Financial Canada. This insurance does not protect the borrower, rather this insurance protects the lender against the borrower defaulting, thereby reducing the lender’s exposure to loss. There is a one-time fee you pay for this insurance, due up front, and is subject to provincial sales tax where appropriate. If you do not have the money to pay this insurance premium, it is borrowed and added to your mortgage.
The fee varies depending on the down payment using the following guidelines:
• 5 percent down payment: Multiply the mortgage amount borrowed by 2.75 percent
• 10 percent down payment: Multiply the mortgage amount borrowed by 2 percent
• 15 percent down payment: Multiply the mortgage amount borrowed by 1.75 percent
Add 0.2 percent to each of the above scenarios if you decide to take a 30-year amortization.
Now take your total down payment amount and add this to the mortgage amount you qualify for. This amount equals your maximum purchase price. For example, if you qualify for a mortgage of $185,000 and your down payment is $15,000 ($185,000.00 + $15,000 = $200,000.00), the result is your maximum purchase price.
Occasionally, a buyer wants or needs a mortgage amount that is slightly higher than what the ratios allow, but due to other debt obligations (e.g., credit cards, student loans) that affect the ratios, the buyer simply doesn’t qualify. Understand that I do not advocate or recommend that a buyer exceed his or her qualification limits; however, sometimes it is possible to find a lender that will allow a debt consolidation or similar program.