Residential > Mortgage Tips:
Everyone is an expert at telling you what-to-do when you're purchasing a home or shopping for a mortgage. Have you ever considered what-not-to-do might be equally important? Our role is to do everything we can to ensure a smooth closing. Here's a list of things that you might not realize could put your mortgage approval in.
What Not To Do List:
Your Credit Score:
FICO Scores are calculated from a lot of different credit data in your credit report. This data can be grouped into five categories as outlined below. The percentages in the chart reflect how important each of the categories is in determining your score.
These percentages are based on the importance of the five categories for the general population. For particular groups - for example, people who have not been using credit long - the importance of these categories may be somewhat different.
Payment History
- Account payment information on specific types of accounts (credit cards, retail accounts, installment loans, finance company accounts and mortgages)
- Presence of adverse public records (bankruptcy, judgements, suits, liens, wage attachments) collection items, and/or delinquency (past due items)
- Severity of delinquency (how long past due)
- Amount past due on delinquent accounts or collection items
- Time since (recency of) past due items (delinquency), adverse public records (if any), or collection items (if any)
- Number of past due items on file
- Number of accounts paid as agreed
Amounts Owed
- Amount owing on accounts
- Amount owing on specific types of accounts
- Lack of a specific type of balance, in some cases
- Number of accounts with balances
- Proportion of credit lines used (proportion of balance to total credit lines on certain types-of revolving accounts
Length of credit History
- Time since account opened
- Time since account activity
New Credit
- Number of recently opened accounts, and proportion of accounts that are recently opened, by type of account
- Number of recent credit inquiries
- Time since credit inquiry(s)
- Re-establishment of positive credit history following past payment problems
Please Take Note:
A score takes into consideration all these categories of information, not just one or two. No one piece of information or factor alone will determine your score. The importance of any factor depends on the overall information in your credit report.
For some people, a given factor may be more important than for someone else with a different credit history. In addition, as the information in your credit report changes, so does the importance of any factor in determining your score. Thus, it's impossible to say exactly how important any single factor is in determining your score - even the levels of importance shown here are for the general population, and will be different for different credit profiles. What's important is the mix of information, which varies from
person to person, and for any one person over time. Your FICO score only looks at information in your credit report. However, lenders look at many things when making a credit decision including your income, how long you have worked at your present job and the kind of credit you are requesting.
Your score considers both positive and negative information in your credit report.
Late payments will lower your score, but establishing or re-establishing a good track record of making payments on time will raise your score.
To Obtain Your Own Credit Report – please visit
Equifax Consumer Services Canada
Article credited to FICO website
Improve Your Credit Score
10 Tips to Improving Your Credit Score
A credit score is an evaluation of your credit history and debt obligations. Lenders use it to assess their risk and establish borrowing conditions. The higher your credit score the broader options you will have as well as access to the best interest rates. Below are a few tips that can help improve your credit worthiness:
- Establish a credit history. Lenders see clients with longer credit histories as less of a risk and more favourable borrowing candidates. Your score will improve as your credit history matures.
- Pay off or lower debt. Try to get accounts down to low or zero balances. If you can get your debt below 50% of the available credit limits, you credit score should improve considerably.
- Do not close existing credit cards. Even if you are not using the credit card, keeping on your credit history will elevate your overall rating.
- Do not max out your credit limits. The more credit you have outstanding, the greater risk you are in the eyes of the lender. This will negatively impact your credit score.
- Check your credit report for accuracy. Errors in your credit report will lower your credit score. Check your credit report annually to ensure it is correct.
- Limit your credit cards. Just because you get an intriguing offer a to apply for a credit card, does not mean you have to. Each application results in a credit inquiry which in turn lowers your credit score.
- Monitor your balances. Paying off your debt and sustaining low balances will help improve your credit score. If you can’t pay off your whole entire balance in one month, pay off as much as you can manage. If your balance creeps up beyond 75% of the available credit limit, it could be interpreted as a warning signal.
- Borrow only what you can afford.
- Pay your bills on time. It is critical to pay bills on time. A late or missed payment over time will have a big impact on your credit score.
- Re-establish your credit history if you have had problems in the past. Opening new accounts with reasonable balances and paying them off on time will raise your score over time.
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Evaluations Excellent Good Take a Closer Look Higher Risk No or Limited Credit History |
Score 730+ 700-729 670-699 585-669 -585 |
Mortgage Tips & Information
Many homeowners are looking to pay off their mortgage as quickly as possible. Below is a list "Pay-Off Tips" to help you decrease your mortgage in an effective and consistent manner.
TIP #1: Increase your payment annually to the most you can afford. Most lenders will allow you to reduce it again to the previous level if it turns out to be too great a burden or your circumstances change.
TIP #2: Use your RRSP tax rebate to pay down your mortgage. Even if you can only prepay annually, make sure these funds are reserved for the purpose of applying to your mortgage. It can be one of those annual surprises that can really help reduce the principle.
TIP #3: Increase the frequency of your payments. Make accelerated bi-weekly payments to get a "free" principal reduction equivalent to one full mortgage payment every year — painlessly.
TIP #4: Round your payments up. By adding even a nominal amount of say, $10 per payment, the amount of interest you are saving will be unbelievable, and the extra money relatively painless to part with.
TIP #5: Pay a lump sum whenever possible. By decreasing the principal of the mortgage, your payments will not be allocated as much to interest in the future, thereby making you mortgage-free faster.
TIP #6: Keep payments the same when mortgage rates have fallen. If the payment amount has not been a problem so far, then do not change it when rates fall. Keep the payment the same thus paying down the principal faster.
TIP #7: Raise payments in line with increased income. If your income increases, don't keep your mortgage payments the same. Just pretend that your income did not increase and maintain your usual lifestyle
Understanding Mortgage Closing Costs
Many homebuyers are unaware of the various closing costs they will need to pay in order to finalize their mortgage financing. It pays for homebuyers to know the specifics of closing costs so they can better prepare for unexpected expenses at such an important time in their lives. The exact closing costs will depend on where you live, how much you are borrowing, how your mortgage is financed, your closing date and mortgage amortization.
Below is a list of the majority of expenses associated with purchasing a home and obtaining mortgage financing. We recommend each of these items be considered and accounted for when preparing your home purchase budget. As every client is unique, so is every mortgage. Costs may vary depending on the mortgage application and not all of the items listed below would be required:
- Property Purchase Tax – a property purchase tax of 1% on the first $200,000 and 2% on the balance will be applicable. If you are a first time home buyer, you are exempt from this tax up to $375,000.00
- Lawyer’s Fees – these vary across the nation and range from $700 to $1200. The Northland Mortgage Team can refer you to a lawyer who offers a competitive “legal package.”
- Mortgage Appraisal Fees – lenders require a written analysis of the estimated value of a property, as prepared by a qualified appraiser. A fee is typically charged for a real estate appraisal because a home appraisal is time-consuming. Appraisal fees fall around $325.
- Land Survey – the legal written and/or mapped description of the location and dimensions of their land, obtained from an accredited land surveyor $500.
- Title Insurance – may be purchased in lieu of a land survey in some cases. Title Insurance provides protection against several defects such as problems with the property that would have been revealed by an up-to-date land survey.
- Land Transfer Tax – buyers must pay this tax to their provincial government when the property’s title passes from the seller.
- Mortgage Insurance – If you are buying a home for less than 20% down you will need to pay a premium of up between 1% and 3.5% depending on the mortgage amount and amortization of the mortgage.
- Home Inspection Fee – a very important part of purchasing a home, the home inspection is an objective visual examination of the physical structure and systems of a house and costs between $250-$400. Getting the Right Advice: The rules and regulations surrounding various mortgage fees are complex. A knowledgeable professional will guide you through the intricacies of these closing fees as they apply to your individual situation.
Top Ten Renovation Paybacks
The real estate appraisers’ top 10 reno projects with the best value per dollar spent.
(The potential percentage payback per dollar invested is in brackets)
- Painting and decorating, interior (73%)
- Kitchen renovation (72%)
- Bathroom renovation (68%)
- Painting, exterior (65%)
- Flooring upgrades (62%)
- Window/door replacement (57%)
- Main floor family room addition (51%)
- Fireplace addition (50%)
- Basement renovation (49%)
- Furnace/heating system replacement (48%)
Residential - Basic Information
This is a question that consumers have been struggling with over the past several years while we have been enjoying historically low interest rates. But how long is this low interest rate environment going to last? The Bank of Canada will increase this rate in order to maintain inflation within its targeted range of 1% - 3%.
While most consumers believe that short term and long term rates move in tandem, the reality is that they do not. Whenever the Bank of Canada lowers its rate, the assumption is commonly made that all mortgage rates decrease as well. This is not the case. The Bank of Canada influences short term rates, but has little or no affect on
longer term rates.
When the Bank of Canada changes its discount rate, all lending institutions quickly follow by changing their prime rate. Since almost all variable rate products are based on the lender's prime rate, this has an immediate effect on the variable rate mortgage. If you are making contractual payments, your payments will rise and fall with the rise and fall of the prime rate. Similarly, if you are making higher than contractual payments to your variable rate mortgage, then the portion of interest vs. principle paid at each installment fluctuates with the rise and fall of prime rate. There are a couple of lenders who offer a "capped" rate on their variable rate mortgage, but most lenders do not offer this protection. Instead, they will allow consumers to "convert" from a variable rate to a fixed rate term at any time, for no fee. The only normal stipulation is that you must stay with the same lender for a combined total of at least three years.
Longer term fixed rate mortgages are directly affected by daily fluctuations in the bond market. You should ask yourself several questions when determining which product is best suited to you:
- Am I financially and mentally equipped to handle fluctuating mortgage rates?
- What is my tolerance for financial risk?
- Am I knowledgeable and diligent in monitoring our economic climate?
- Can I/will I react wisely to market fluctuations? - Do I have the peace of mind associated with fixed mortgage payments?
By managing the variable rate product, some consumers have been able to pay down their mortgage substantially. Experts now agree with the benefit of hindsight that over the past ten years one would have paid less interest by taking a short term or variable rate mortgage versus a longer term mortgage. But that strategy might not be for everyone. Your honest answers to the above questions will help guide you to your best choice. The only sure bet to protect yourself against future interest rate hikes is to opt for a longer term fixed rate mortgage. Most lenders offer fixed rate terms up to 10 years.
Why Use A Mortgage Broker?
For most of us, our ideas about mortgages have been instilled by years of past experience with traditional products in traditional institutions.
Long-held beliefs sometimes include the idea that mortgage brokers are only for people who have bad credit or were turned down by a bank. Unfortunately, anyone with this kind of outdated thinking could be losing thousands of dollars! All homebuyers and homeowners can save time and money by enlisting the services of a broker.
A mortgage broker has access to many competing lending institutions, including banks, pension funds, trust companies and even private individuals. Since mortgage brokers do not have to sell the products of any one lender, they can be completely unbiased in recommending a mortgage that has the most attractive rate and features for their clients. While you may arrange a mortgage every five years, a mortgage broker and his or her firm are completing thousands of mortgages each year.
This enables them to negotiate better interest rates based on that volume, which can be passed on to their clients. There are other potential cost savings. On any given day, a particular lender may have a special rate offer for a specific mortgage term. If you are rate shopping on your own and do not know who is sponsoring the offer, you can not take advantage of the special pricing. At renewal, many homeowners take the renewal quote and choose a term and rate offered by the lender without realizing that a mortgage broker may be able to save them up to one percentage point off the posted rate. This can translate in thousands of dollars in savings over a five-year term. To ensure you get the best rate, it is best to contact a mortgage broker at least four months before you renew or consider a new home purchase. Starting early can be a money saver because your broker can usually guarantee an interest rate for 90-120 days. Should rates drop in the meantime, you would of course get the lower rate. If your credit rating is important to you, then you also need to consider that when you shop from lender to lender, there is an accumulation of inquires on your credit bureau report, affecting your credit rating and ultimately the rate and terms of your mortgage. This is not the case with a mortgage broker who only does one inquiry yet can still get many competing lenders to quote on your business. And finally, an important misconception that should be discussed about fees. Some people think that using a broker will be costly, and that there will be an upfront fee. In most cases, there is no fee because the lender that provides the mortgage pays the mortgage broker a fee for originating and negotiating the mortgage. As you would expect, a fee may still be charged to clients with impaired credit, or when private money is used, although this compensates for the time and effort required to negotiate the mortgage.
Appraisals and Inspections
When you are buying a home you will want to know two things, if you are paying the right price, and if the condition of the home is as promised. To determine the value of the home you may need a professional appraisal. If you are taking out a mortgage loan the lender usually requires a professional third party appraisal of the home to determine the lending value.
Appraisal
A real estate appraisal is quite different from a property inspection, although they do overlap in their scope and procedure. A real estate appraisers job is to determine the value of the property. Usually the appraiser is estimating the market value of the land and building for mortgage lending purposes. Often the scope of the appraisal does not include a detailed property inspection, in many cases an estimate of the value can be reached without a comprehensive inspection of a residential property, particularly if most of the value is in the land and not the building. For mortgage lending purposes the financial institution may only require a determination that the property is sufficient security for the mortgage. Mortgage lenders are also concerned that the condition of the property is such that costly expenditures on repairs or renovations will not cause an unmanageable financial drain on the borrower. Home buyers are increasingly turning to property inspectors to insure that the home not only represents good value for the purchase price but is also in good shape.Inspection
The home inspector offers no opinion on the value of the property. Their function is to inspect the adequacy and condition of the building and all major systems. A home may be of sufficient "appraised" value to get the mortgage, but a closer look at the building and systems may reveal that costly repairs are on the horizon. Your inspection will point out any red flags and areas of concern. Many inspectors will supply you with a schedule outlining the estimated cost to remedy or repair the problems noted. In addition most inspections will estimate the timing of any suggested repairs and prioritize the seriousness of any adverse findings. Armed with this information the purchaser can then make an informed decision on whether or not to proceed with a purchase offer.It is important to hire a qualified and experienced home inspector. In Canada the home inspection industry is, for the most part, self regulated by a number of trade organizations. Contact one of these organizations to refer you to a home inspector.
GST Tax on Home Purchases
Until, or if, the federal government changes the GST, you will be required to pay it if you buy a new home that's newly constructed or substantially renovated.
The good news is that you may be eligible to claim a rebate for a portion of the GST or amount you pay on the purchase price or cost of building your new home if you meet one of the following:
- You buy a new or substantially renovated home and buy or lease the land from a builder.
- You buy a new mobile home, new floating home or new modular home from a builder or seller.
- You buy a share in the capital stock of a co-operative housing corporation.
- You construct or substantially renovate your own home or hire another person to do it.
- Your home is destroyed in a fire and is substantially rebuilt.
Builders from whom you purchase your new or substantially renovated home, mobile home, or floating home can pay or credit you with the amount of the rebate for which you qualify. If they do, they are responsible for sending the rebate application to Revenue Canada.
Should you decide to apply directly to Revenue Canada for the rebate, you must use the appropriate form available from any Revenue Canada Excise/GST district office.
The rebate applications involve the purchase of a new single unit residential complex or a residential condominium unit from a builder. To apply for the rebate you need to meet all of the following conditions:
- The builder sells both the building and the land the home is on.
- The home is intended as the primary place of residence for yourself or a relation.
- The purchase price of the home (both building and land) is under $450,000.
- Ownership of the home is transferred to you after the construction is substantially completed.
- You or a relation are the first occupants, or you sell the home and transfer ownership before anyone occupies it.
- You pay GST, or GST is included in the price of the home.
Buyers purchasing such homes priced up to $350,000 will qualify for the maximum rebate of $8,750, or 36 per cent of the GST paid on the purchase price, whichever is less.
For homes priced at more that $350,000, but under $450,000, the rebate is gradually reduced. There is no rebate for homes selling for $450,000 or more.
Example A - Purchase price/fair market value (not including GST) is under $350,000
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Purchase price GST paid (6% of purchase price) GST rebate ($12,000 x 36%) |
$200,000 $ 12,000 $ 4,320 |
Example B - Purchase price/fair market value (not including GST) is over $350,000
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Purchase price GST paid (6% of purchase price) GST rebate Calculation: |
$400,000 $ 24,000 $ 4,375 $450,000 minus $400,000 (purchase price) = $50,000/100,000 X $8,750 = $4,375 |
Title Insurance
Title insurance, which has been used in the United States for more than 100 years, protects your "title", otherwise known as the right of ownership in real property. Since 1991 when it made its way to Canada, title insurance has saved home buyers money and aggravation, helped close transactions on time, and resolved potentially deal-breaking title and survey problems.
Used by consumers, lawyers, lenders, mortgage brokers, and real estate brokers, title insurance is available for residential and commercial transactions alike. It protects against a variety of problems that can delay a transaction, prevent it from closing, or
threaten the purchaser's rightful ownership. Among the problems it insures against are fraud and forgery as they relate to title, title defects, survey problems, human error and the inability to market the property at a later date.
A policy of title insurance can also reduce the costs a homebuyer incurs during the home closing process. It eliminates many of the searches a lawyer would normally do, reducing the disbursement costs that you incur. With all major financial institutions now accepting title insurance in lieu of an up-to-date survey, clients can save the time and cost of having a survey prepared. They also avoid the delay and cost they would incur to remedy any problems a survey would have revealed.
Title insurance companies assume the risk that a homeowner may be required to remedy a title problem at a later date. When covered title problems arise, it is the role of the insurance company to correct the problem or pay for any loss the policyholder incurs up to the policy amount. Additionally, all title insurance companies pay for legal costs incurred in defending title against the claims of others.
Title insurance also can be used to insure over known title or survey defects. Depending on the problem, title insurance companies will sometimes provide coverage for issues that would otherwise prevent a deal from closing problem free. For example, when the home buyer has the same name as someone with a court judgment against them and the bank refuses to release funds, even though the purchaser signs an affidavit confirming this person is not them, title insurance can be used to ensure the transaction closes. Or if it is discovered that the garage or pool of the house being purchased extends onto a neighbouring property, a policy of title insurance can cover the cost to remove the encroaching structure, should this become mandatory. In instances like these, title insurance saves purchasers the cost and inconvenience of having to repair problems, allows the transaction to close on time, and sometimes may even save the transaction.
On average, the cost for two title insurance policies - one for the homebuyer and one for the lender - is $250. This figure varies by province and according to the type of property involved. Title insurance is available through lawyers right across Canada. In order to maximize cost savings, you should tell your lawyer that you would like a title insurance policy early in the purchase process.
Rates And Products
RATES
Yes, interest rates are very important, however .....
There is a lot more to mortgages than just the rate!
Especially now, as more lenders and more products are being brought to the markeplace than ever before!
We will take the time to educate and inform you about all of the products available, your options and your mortgage strategy, so that you can then make an informed choice. Once you have made a decision on the best mortgage product that will suit your needs, we will guarantee you the most competitively priced product in the mortgage marketplace.
PRODUCTS
Northland Mortgage offer competitive and new to the Canadian Mortgage Market
products specifically designed for;
- First time or move up buyers,
- Refinancing or consolidation mortgages,
- Renewals/switches,
- Self Employed clients,
- Investment / Rental properties,
- Recreational properties,
- No down payment mortgages,
- Clients with past credit issues,
- Clients with no documentation.
- Commercial mortgages
The Mortgage Application and Approval Process
The first stage of the mortgage lending process involves filling out the application, verifying the information on this application, and confirming the value of the property. The process of determining the risk of an application, and whether to approve it, is called underwriting.
The underwriter considers three primary components of each application. The task of underwriting is to determine the borrowers ability to repay the funds under the agreed upon terms, their willingness to repay, and the adequacy of the real property as security for the mortgage loan.
1. The current financial position of the applicant.
Net Worth
The applicants net worth is determined to decide their overall financial well being. Of particular concern is the verification of available net worth for the purpose of down payment. The accumulation of assets beyond liabilities can be used as a general test of the applicants personal finances and income management in prior years.
Gross Income
One of the most important components of the loan underwriting process is determining the borrower's gross income. The income of all borrowers and co-borrowers is included in the calculation. The income can be derived from several sources, but it must be supported by historical documentation and have a high likelihood of continuation in the future. The underwriter is concerned with the quantity of income earned in order to determine the maximum mortgage allowable, and also the durability of these earnings to insure that the borrower will be able to make their mortgage payments for the full term of the mortgage.
The following outlines the types of income that may qualify as well as the verifications required to confirm them:
Salary: Income derived from any kind of salary, whether monthly, weekly or hourly is acceptable. Two or three years employment history is usually required.
Commission and bonus: Commissions and bonuses may be qualifying income if it is an ongoing and persistent component of overall earnings. To verify this the underwriter will average the last two or three years of income shown on your income tax returns and the year-to-date earnings from the written verification of employment or pay stubs. The task if to determine if this income is likely to continue in the future, and at what levels given the employment type.
Self-employment income: Generally, the underwriter will average the income earned through self-employment for the last three years from the applicant's income tax returns and the year-to-date earnings from a profit and loss statement of the business. Self employment can take many different forms so the underwriter will require as much supporting evidence as possible to determine and verify qualifying income. In determining the current amount of qualifying income generated by self employment the underwriter will take into consideration the trends in your business or industry in an effort to forecast future prospects.
Other Income: Income earned from rental properties, interest, dividends, pensions, and social security can be used, as long as it can be verified and will persist long into the future. Some incomes are discounted, or do not qualify at all, for the purposes of mortgage loan application. One time gifts or windfalls are not income nor is occasional overtime or a single bonus from your employer if it is not likely to be received again. In general, unemployment benefits or other insurance's with a finite disbursement period are not considered.
Funds to Close:
When the proposed loan is being used to finance the purchase of a home, the lender will determine the source of funds for the down payment as well as closing costs. The mortgage lender is verifying that closing costs and down payment amounts are not also going to be borrowed and have been accumulated over time from the borrowers own resources.
The following are acceptable sources of funds for closing:
Funds on deposit: Money that has been on deposit for at least 60 days in checking or savings accounts at any depository institution or investment company is acceptable, so long as it can be verified on bank statements for the past two months.
Stocks, Bonds, Mutual Funds, etc.: Cash equivalent investments are acceptable forms of funds. They can be validated through statements from investment companies for the last two months.
Sale of existing property: Many times the source of funds for the down payment on a home comes from the equity in a property that will be sold. The sales price of the property being sold is indicated on the loan application and any existing loan is verified on the credit report or through a verification of previous mortgage. The contracts of purchase and sale must be submitted to the mortgage lender in order to verify that the proceeds of disposition are sufficient and closing dates are in order.
Gifts from family members: Gifts from family members for the down payment and/or closing costs are acceptable so long as there is no requirement for repayment. CMHC will require the execution of a gift letter as proof that the gift is bona fide.
CMHC requires the borrower to demonstrate their ability to cover closing costs in the amount of 1.5% of the value of the property. Closing costs can be equal to as high as 3% of the value of the property being purchased and can vary widely depending on the property being purchased, services required, taxes and insurance's applicable, whether the home is new or old, closing dates affecting interest adjustments, and the balances of any prepaid expenses.
Closing cost are typically one time fees that must be paid as a result of the purchase transaction. Other immediate costs are also incurred as a result of a home purchase. These include moving costs, costs to ready the home for your family, insurance coverage, lock smith and security costs, renovation costs, household affects such as drapes, appliances, and furnishings, and the installation of telephone - cable and internet access etc.
2. How Much Home Can You Afford
Once the lender has determined the applicants qualifying gross income and expenses they will calculate whether the applicant can afford the mortgage loan based on their ability to carry the shelter costs. Lenders use a ratios approach to determine this ability by setting maximum expenditure amounts.
Shelter costs include:
- The Mortgage Payment
- Property Taxes
- Condominium Maintenance Fees
- Heating Costs
Gross Debt Service Ratios (GDSR)
The GDSR is the ratio between gross income and shelter costs. The lender will set an upper limit on this ratio. As a general rule mortgage lenders will not allow you to spend more than 30% to 32% of your gross income on shelter costs. If the sum of the mortgage payment, property taxes, condo fees and heating costs exceeds the lenders stipulated Gross Debt Service Ratio, the mortgage will likely be declined, or a revised loan amount offered.
Assume the applicants monthly gross income is $5,000 and they are applying for a mortgage of $200,000 at an annual rate of 8% to be repaid over 25 years. The monthly mortgage payments would be $1,526. The lenders maximum GDSR is 32%.
The lender will add up the shelter costs related to the purchase of the subject property. In this case it is a single family dwelling with property taxes of $100 per month and $50 per month heating costs.
The Shelter Payments amount to 33.5% of the applicants gross income, higher than the maximum allowed by the lender. As such the lender will reduce the financing available to the applicant in line with the 32% GDSR maximum.
With Gross Income of $5,000 per month and a maximum GDSR of 32% the lender will only permit the applicant to have a maximum shelter payment of $1,600 (32% of $5,000)
By subtracting the property taxes of $100 and the Heating Costs of $50 we are left with the maximum gross income available for mortgage repayment. In this case $1,450. This is the applicants maximum mortgage payment.
The $200,000 mortgage the applicant has requested results in a mortgage payment of $1,526 at current interest rates of 8 %, exceeding the applicants maximum mortgage payment and pushing their GDSR above the limit.
The lender will calculate the maximum loan amount using the applicants maximum mortgage payment of $1,450. This results in a maximum mortgage of $189,986, given the current interest rate.
The applicant will have to provide a larger down payment in order to proceed with the purchase of the subject property. Given that their maximum mortgage is $10,014 less than they had anticipated they will have to provide these funds from savings or they will be forced to look for a more affordable home.
Total Debt Service Ratios (TDSR)
The TDSR is the ratio between the sum of both shelter and non shelter financial obligations combined, and gross
income.
The lender is concerned with the applicants ability to carry costs other than simply the shelter payments. The maximum the applicant will be allowed to spend on both shelter and non shelter financial obligations combined is usually set at 40% to 42%. Total Debt Service Ratios above 42% result in payments that are likely to be unmanageable for the borrower in the long term.
Disregarding the applicants other financial obligations could mean approval of a loan to a borrower that has substantial non shelter financial obligations and may increase the risk of mortgage payment default.
Non Shelter Financial Obligations include:
- Car Payments
- Credit & Charge Card Payments
- Personal Loans
- Lines of Credit
- Finance Company Loans
- Long Term Leases (more than 1 year)
- Tax loans
- Long term RRSP catch up loans (more than 1 year)
If the applicants GDSR is at the 32% maximum they will must not have more than 8% of their gross income committed to non shelter financial obligations, 42% in total.
How Personal Debts Can Affect Housing Affordability
If the applicants existing non shelter financial obligations are, say 18% of their gross income, the income available for shelter financing is squeezed and reduced to 24% of their gross income. 24% of the applicants $5,000 gross income results in a maximum shelter payment of $1,200. If we subtract the heating cost of $50 and the property tax costs of $100, the resulting maximum mortgage payment is now $1,050.
$1,050 will finance a mortgage in the amount of $137,576 at 8% per annum. This is substantially lower than the $189,986 the applicant would qualify for based solely on the GDSR. The applicants non shelter financial obligations are having a negative impact on housing affordability by reducing their available financing and consequently the applicants purchasing power.
In the graph below the applicant has credit card payments of 7% of gross income and car payments of 6% of gross income. The combined non shelter financial obligations of the applicant equals 18%.
After Taxes Ratios
The debt service ratio above may appear to leave a good deal of income for all other expenditures. However these ratios are based on gross income and not after tax income. A look at the applicants remaining income after taxes reveals a different picture.
The graph below displays a the maximum GDSR of 32%. After taxes these shelter costs constitute 49% of their disposable income.
The remaining 35% of after tax income does not leave the borrower with much room. In the case of our applicant with a gross income of $5,000 the remaining after tax income they will have is only $1,150 per month. These remaining funds must pay for all other expenses such as food, clothing, medical and dental, vehicle maintenance and operating costs, entertainment, personal property, and savings.
Gross Debt Service Ratios and Total Debt Service Ratios are the maximums set by mortgage lenders.
Purchasers may consider opting for longer mortgage terms in order to avoid the risk of rate increases. In addition, many purchasers are wisely advised to pay down their mortgage, particularly if a renewal at lower interest rates has resulted in a lower mortgage payment.
Set Your Own Debt Service Maximums
While these maximums set risk guidelines for mortgage lenders, the applicant should also calculate their own maximum GDSR and TDSR. In many cases the lenders maximums are too high for an applicant who wishes to have a little more spending money in their pocket each month. Applicants know their lifestyle priorities and spending habits far better than the mortgage lender. The maximum shelter costs a borrower can handle should be carefully determined by the family regardless of what the lenders maximums are.
3. Creditworthiness
Credit Analysis:
Another very important part of the underwriting process is determining the creditworthiness of the borrower. Loan underwriters review the borrower's credit report to find evidence of debt repayment behavior. Some of the important areas that are reviewed are:
Past and existing mortgage debt: The past repayment history on mortgage debt can be a good indication of a borrowers attitude toward mortgage obligations. A good payment history on mortgage debt is very important in the credit analysis.Generally, payments received 30 days past the due date are reflected in the credit report as late. Lenders vary in strictness, and some may not allow any late mortgage payments, while others will allow 1 or 2 in the last two years if there is a good explanation.
Installment and revolving credit: Other items on the credit report can also indicate a borrower's attitude toward their financial obligations. Credit reports indicate the outstanding balance, payment amount, and terms of payment on the borrower's revolving and installment debts. Underwriters review these credit obligations to determine the borrower's patterns of credit use and repayment behavior. Revolving credit refers to department store credit and bank credit cards. Installment credit refers to longer term credit with structured payment plans, such as car loans. Generally, underwriters are not concerned over isolated and minor slow payments indicated on the credit report. They look for an overall profile of the applicants attitude towards their financial obligations.
Collections, repossession, foreclosures and bankruptcies: Credit reports also indicate public records such as collections, repossessions, foreclosures, and bankruptcies. Though these items may indicate past credit problems, they sometimes have valid explanations. Underwriters may require a letter of explanation on items noted in the public records. Many times consumers have re-established credit and have an excellent payment history on their current obligations. It is important to forewarn the lender if there is an item on your credit report that requires explanation. Provide that explanation in detail so that the underwriter is comfortable with it.
Some lenders will approve applicants that have previously been bankrupt provided they have since re-established a good credit history and the cause of the bankruptcy was reasonably not the fault of poor credit management on the part of the bankrupt.
CMHC will, on a case by case basis, approve applicants that have been bankrupt provided two years has passed since they were discharged.
4. The Property
The home is the collateral for the mortgage loan. The lender must determine that the property offers adequate value as security in relation to the mortgage loan amount. In addition they must determine whether it is likely that there will be any capital or maintenance costs that would put a drain on the applicants financial resources and could affect their ability to manage their mortgage payment obligations in the future. In order to make this decision the underwriter hires a professional real estate appraiser. The appraiser will submit a report detailing their estimate of the value of the residence based on the recent sale of comparable properties in the area.
The underwriter will be particularly interested in the overall value of the property to ensure that it sufficiently covers the mortgage loan within the required loan to value ratio limits, usually 80%. The age and condition of the property determines its' remaining economic life. No mortgage amortization should exceed the economic life of the property. Properties in poor repair will likely cost more in maintenance or renovation in years to come. These costs are factored into the analysis.
Loan to Value Ratios (LVR)
The loan to value ratio is calculated by dividing the mortgage (s) by the property value or purchase price. This ratio sets another upper limit on the amount of financing a lender will provide to a qualified purchaser.
Mortgage lenders typically lend based on the borrowers ability to afford the costs associated with the property and financing. The amount of mortgage an applicant receives is determined by the borrowers debt service ratios and the value of the property. If the subject property has a lending value of $200,000 the maximum mortgage loan the lender will provide is usually 75% of this value, regardless of whether the applicant qualifies, from an income perspective, for a mortgage of $200,00. The lender will only approve a mortgage of $150,000 on this property unless the added risk of the high ratio loan is insured away by mortgage default insurance.
Mortgage lenders want to ensure that the applicant will have a sufficient stake in the property. In addition their equity contribution must be adequate enough to cover all costs and balances owed in the event that the lender has to take possession or sell the property. These costs can include legal proceedings, accrued interest, property repairs, insurance's, marketing expenses and Realtors fees as well as added administration costs. The equity also acts a safety buffer in the event that property values decline in a slower market.
Conventional Mortgage
Mortgages with a loan to value ratio of 75% or less are termed Conventional Mortgages. 75% is the maximum a lender can advance. If the applicant requires more financing they will have to purchase mortgage insurance
High Ratio Mortgage
High Ratio Mortgages have a LVR above 75%. The risk of these loans is substantially increased due to the lower amount of owner equity. Mortgage lenders will only allow an applicant to have a high ratio purchase mortgage if the applicant insures the mortgage through one of Canada's mortgage insurers, GE Capital Mortgage Insurance Services Canada or Canada Mortgage and Housing Corporation. By insuring the mortgage the applicant will be able to receive financing up to 95% of the value of the property. This substantially reduces the down payment requirement and allows more families to buy a home earlier.
Underwriting Conclusion:
After the underwriter has reviewed the entire loan package, there can be four outcomes:
Approval:
If the loan is "picture perfect" and the underwriter has no questions, the loan will be approved with no conditions.
Approved with conditions ( the most common response):
(a) If the underwriter needs additional documentation before a final credit decision can be made, a conditional approval will be given. In essence, the loan documents will not be prepared until the condition has been satisfactorily met. An example of a condition could be a pay stub to validate the borrower's income.
(b) If the loan can be approved, but a condition must be met prior to closing, a "prior-to-funding" conditional approval will be given. In this case, the loan documents will be prepared and sent to the lawyer, but the lender will not fund the loan until the condition has been met. An example of a "prior to closing" conditional approval could be proof of sale of existing home where the equity will be used as the down payment.
Suspended:
In this case there is insufficient documentation of verification to decide whether or not to approve or decline the applicant. The mortgage lender will request the information and will set the file aside until these items are delivered.
Denial:
Underwriters will be unable to approve a loan if the loan file has substantial deficiencies and does not meet the minimum standards of the lender or the lender's secondary market investors. Some lenders require that a second underwriter review the loan package before a final denial is communicated to the borrower. Underwriting criteria can be different among lenders and a borrower may be able to find other acceptable financing alternatives in the market place.