Pre-Qualify For Mortgage Without Going To The Bank!
If you are on the journey of buying a house, the first thing that will pop into your mind is, “How much can I afford?” This is where mortgage pre-qualification can help you. One of the key reasons for getting a pre-qualification is that it helps to establish a budget. You will then be aware of what type of a home you can buy and where you can buy it. Also, in this step of the mortgage process, you do not have to furnish any personal details. This guide will give you a practical view on how you can pre-qualify by yourself.
What is pre-qualification?
To be clear, there are three terms involved in the mortgage process, they are pre-qualification, pre-approval and mortgage agreement. They are all different and should not be confused. This is about the initial stage.
Mortgage pre-qualification is an estimate of how large a mortgage you can afford based on your financial situation over the past few years.
It is a relatively simple process where you supply your lender with information about your financial situation including income, assets, and debt.
For serious homebuyers, the pre-qualification process is an important first step. But many first time home buyers are not aware of this. As lending guidelines have gotten stricter, it’s crucial to know where you stand before setting your sights on a Mansion you just can’t afford! Also, a pre-qualification shows your agent or broker that you are officially into the home-buying process and it gets their attention.
DIY Mortgage Pre-qualification
When you prequalify for a home loan, you’re getting an estimate of what you might be able to borrow.
- It is based on information you provide about your income, assets, and debts
- It is usually offered at no cost
- Prequalification is neither pre-approval nor a commitment to lend; you must submit additional information for review and approval.
This should be an easy and quick process that you can do by yourself in minutes. You can do it without the need to go to the bank or lender saving yourself some time at this stage.
Here is a detailed guide to help you do this!
Basic information needed for prequalification
You can get a fairly good idea of what you qualify for with only the following bits of information
- Your gross household income (if a couple, income of both)
- Amount saved for down payment and closing costs
- Monthly living expenses
- Your gross debts (including car loans, educational loans, credit cards and other forms of credit)
- Mortgage rates (Assume for 5 years fixed, 25 years amortization)
- Your credit score
Lucy and William have a combined annual income of 100,000 CAD, with savings of $50,000 towards down payment. Their monthly expenses are as follows
- $1500 as living expenses
- $1500 towards credit card and car loan payments.
Assuming a 5 year fixed mortgage plan to be paid over 25 years, at an interest of 5.59%, they can afford a house up to $331,000 with a monthly mortgage payment of $1778.
(This amount is determined by taking into account the GDS and TDS ratios. To get an idea on these, read below.)
To assist you in estimating how large a mortgage you can afford, here is an example of a mortgage calculator you can use. (Click the image below)
The ways a lender determines affordability and the way you determine affordability are probably very different. That’s why it’s a good idea to understand how lenders calculate your affordability and the formulas they use to do so. This is to ensure that you are not in for any nasty surprises.
Gross Debt Service Ratio (GDS) and Total Debt Service Ratio (TDS) are two mortgage formulas that lenders use to determine exactly how much money they are willing to lend you. Fortunately, you can make these calculations for yourself before applying for your mortgage.
Let’s explore what each of these ratios means and what the exact mortgage calculation formula is.
GDS (Gross Debt Service Ratio)
The GDS ratio is the percentage of your income needed to pay all of your monthly housing costs, including principal, interest, taxes, and heat (PITH)., and additionally, 50 percent of your condo fees, if applicable. The majority of lenders abide by a general standard of 35 percent, so your GDS should be lower than that to qualify for a mortgage.
To calculate your GDS ratio, you’ll need to add all of your monthly housing-related costs and divide it by your gross monthly income. Then multiply that sum by 100 and you’ll have your GDS ratio.
TDS (Total Debt Service Ratio)
Your TDS ratio is the percentage of your income needed to cover all of your debts. The TDS calculation is the same as that of the GDS, except all of your monthly debts are taken into consideration. This includes car payments, credit cards, monthly payments, and any loans. The industry standard for a TDS ratio is 42 percent.
To calculate your TDS ratio, add all of your monthly debts and divide that figure by your gross monthly income. Then multiply that sum by 100 and you’ll have your TDS ratio.
What if your ratios are higher than the industry standard?
The first thing to remember is that these ratio percentages are simply industry guidelines and vary from lender to lender, both within the same category of the lender as well as across different types of lenders (banks vs. non-depository lenders, B-lenders(unregulated lenders) and private lenders.
Therefore, they are not set in stone. Some lenders will emphasize other factors when determining the validity of an applicant.
E.g.: John wants to buy a condominium. With an annual salary of $65,000, his gross monthly income is $5,417. He estimates that the mortgage payment on his home will be $1,650, his monthly bill for his property taxes will be $125, heat is $35, and condo fees are $500. He also has a student loan payment of $550.
GDS: $2,060 / $5,417 = .38 x 100 = 38 per cent
TDS: $2,610 / $5,417 = .48 x 100 = 48 per cent
As you can see, Both of John’s ratios are too high according to industry standards. John could benefit from choosing the building with a less expensive condo, lesser condo fee, which would lower both of his GDS and TDS ratios. He could also try to eliminate his credit card debt to boot.
The easiest and simplest ways to decrease your ratios are paying off some of your debt load, increasing your down payment, or adding rental income. If you will be living with a partner and don’t have them added to the application for some reason, then consider doing so if it will add income to the equation.
In some cases, where the down payment for that loan was less than 20 per cent, which requires it to be insured by the Canadian Mortgage and Housing Corporation (CMHC) or by private insurers , the GDS or TDS can be as high as 39 to 44 per cent with a credit score of at least 680.
According to the CMHC, it’s important to note that “Debt service flexibilities are based on an assessment of the strength of the overall application. Satisfying the minimum credit score alone does not automatically entitle the borrower to debt service flexibilities.”
Another option which was mentioned in John’s example (that many people don’t like to confront) is to buy a less expensive home, whether that means one with a lower sales price, lower operating/heating costs, or lower property taxes in a different area.
GDS and TDS ratios are just a small component when looking at your overall suitability as a borrower, but it gives lenders a way to figure out whether or not your income will cover the costs of your mortgage. Also, they don’t tell the whole story – they don’t take other basic expenses into account like transportation or food. So you want the ratios to be as low as possible to leave room for all of your other incidentals.
To assist you in estimating how large a mortgage you can afford, we recommend that you use the mortgage calculator linked below: (Click the image)
Mortgage terms and definitions
The amortization period is the total number of years it takes to pay off your mortgage loan completely. You choose the number of years when you apply for a mortgage loan. Most first-time buyers typically pick the longest amortization period available. If your down payment is less than 20%, your maximum amortization period is 25 years. If your down payment is greater than 20%, you could have an amortization period of up to 30 years. The longer the amortization period, the lower your principal and interest payments will be, but overall, the amount of interest you’ll pay will be higher. With a shorter amortization period, you’ll make higher principal and interest payments, but you will pay less interest in the end.
A mortgage term is the length of time you’re committed to a mortgage rate, lender, and associated conditions.
Closing Costs are the costs that the buyer must pay during the mortgage process. There are many closing costs involved ranging from attorney fees, recording fees and other costs associated with the mortgage closing.
Down Payment is the amount of the purchase price that the buyer is paying. Generally, in Canada, lenders require a minimum of 5% down payment in order to qualify for the mortgage. Buy, a down payment lesser than 20%, qualifies as a high-ratio mortgage. (See below for definition)
Fixed Rate Mortgage is a mortgage where the interest rate and the term of the loan are negotiated and set for the life of the loan. The terms of fixed-rate mortgages can range from 10 years to up to 40 years.
Variable rate mortgage is a mortgage where the interest rate can fluctuate along with any changes in the mortgage rates. Your principal and interest payments will stay the same for the term, but if the mortgage Rate goes down, more of your payment will go towards the principal.
An open mortgage is best suited for those who plan to pay off or prepay their mortgage loan without worrying about prepayment charges. It allows you the freedom to put prepayments toward the mortgage loan anytime until it is completely paid off. An open mortgage may have a higher interest rate because of the added prepayment flexibility.
Closed mortgage provides the option to prepay your mortgage loan each year up to 15% of the original principal amount. If you want to pay your mortgage loan off completely before your term ends, prepay more than 15%, or pay off your mortgage loan balance before the end of its term, prepayment charges may apply. A closed mortgage typically has a lower rate than an open mortgage for the same term.
Canada Mortgage and Housing Corporation (CMHC) – The Canada Mortgage and Housing Corporation is one of the providers of mortgage loan insurance. This insurance protects the mortgage lender against loss if a borrower defaults.
Foreclosure – A legal process whereby the lender eventually takes ownership of the property after the borrower has defaulted on payments or other terms of the mortgage loan
High Ratio Mortgage – If a buyer’s deposit is less than 20% of the purchase price (or value of the property, whichever is lower) the mortgage must be insured against payment default by a Mortgage Insurer, such as CMHC.
Pre-approved and pre-qualified are not the same things. Don’t assume that the bank will provide your loan until you have been pre-approved. The mistake could cost you your new home, so before you meet with the banks, do your homework by getting pre-approved.
Pre- Qualification is based on the information you provide. You may not be approved for the amount that you qualified for. It is an indicative amount. It’s just the amount for which you might expect to be approved. For this reason, being a pre-qualified buyer doesn’t carry the same weight as being a pre-approved buyer whose documents have been reviewed and validated by the lenders.
With pre-approval, you will receive a conditional commitment in writing for an exact loan amount, allowing you to look for a home at or below that price level. Obviously, this puts you at an advantage when dealing with a potential seller, as he or she will know you’re one step closer to obtaining an actual mortgage.
With so many questions and concerns, you, as a buyer may be overwhelmed. This is where ReVa can help you. ReVa will connect you top-rated mortgage brokers who are experts in their fields. ReVa will match your preferences with the expertise of the professionals and connect you to the best possible choice. With ReVa by your side, you can rest assured that you are connected with the best!