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6th Episode - How do Financial Institutions think to determine the eligibility of a mortgage?

Hello, how are you?, welcome back, in this Episode we are going to talk about how a lender reviews your mortgage application.

Recapping information from the previous episodes, it is important to know how a lender determines whether you are eligible for a mortgage or not.

Each lender has its own guidelines when it comes to mortgages. It can be approved by one lender and not approved by another, or you can see different pre-approval amounts between different lenders. Mortgage guidelines can change from one lender to another; however, there are some commonalities between the policies of different lenders.

One of the Pillars of the Credit System is the Financial Situation of each Person; and within this, these are some of the main criteria that a lender will review to determine your creditworthiness.

First: Your credit rating

As we saw in episode 5, your credit score is a number that a lender uses to determine if you are strong or weak in managing your finances. The lower the credit score, the riskier it is for the lender. Most lenders have a minimum credit score requirement. Inside the credit report, there is also a detailed breakdown of who has been checking your credit as well as a breakdown of your individual credit items and your payment history. Your credit score is a very important factor in determining your creditworthiness for a new mortgage.

There are two main credit bureau companies in Canada, which are Equifax and Transunion. The Equifax credit bureau has a maximum rating of 900 points. In general, financial institutions ask for a minimum score of 720, some accept 680, others 650, but to the extent that they accept lower scores, the repayment risks for them increase and therefore the mortgages have higher rates and more conditions.

Second: Loan to Value

The value of the loan is fixed by the size of the loan in relation to the value of the home. For example, if you are buying a house and putting in a 5% down payment or initial payment, as we saw in the first and second episodes, then, the value of your loan is 95% of the house value. With that, the mortgage is 95% of the value of the home.

When buying a home in Canada, the typical minimum down payment is 5% of the purchase price of the home. However, there are options to obtain a mortgage without saving on the down payment. We will talk about that in another podcast.

If you want to obtain funding based on a real estate property you already own, that is called refinancing. A person can typically borrow up to 80% of the value of a home through a traditional loan, and up to 85% of the value of the home through alternative or private loans.

Third: Borrower Capacity (Repayment Capacity)

The assessment of the ability of a borrower to pay the mortgage is one of the main objectives of the lender. In Episode 5 we discuss the importance of this issue. There are a variety of factors that help determine the borrower's ability to pay the mortgage. Factors include income, assets, and liabilities. For the income, the lender will look at the stability in employment and income flow. For assets and liabilities, the lender wants to see that you can not only save for the down payment, but you can also save for closing costs and emergencies.

In this regard, the lender will look at how your annual income relates to your mortgage application.

To help the lender determine your creditworthiness or solvency, your annual income is an important component of this. The more consistent your income, tenure, and job stability, the better. Within your income, the lender wants to see stability. Being new to your job is fine as long as your income is guaranteed. For most non-salaried jobs, such as self-employment or self-employment, a lender will use an average of the last two years of your income.

In Canada, in general, a person can qualify for a home approximately 4.5 times their annual income. So, if you make $100,000 per year, as an individual or as a total for the household, you may be able to buy a home up to $450,000. However, this amount may vary from applicant to applicant depending on your debts, the amount put forward as the down payment, and the property itself.

You can see that the higher your income, the higher the purchase price you can achieve. Also, by working the formula backward, if you see a house that you want, such as a house priced at $495,000, if you divide this by 4.5, you will discover the approximate income required to achieve this house, which in this example will be $110,000 per year.

If you have a fixed salary plus bonuses, a lender will typically use your established base salary and then a two-year average of the bonus.

Fourth: Labor Stability

Therefore, we must ask them the following: How does your job affect your mortgage application? o How does job stability affect your mortgage application?

Financial Institutions focus less on the amount of their income and more on the stability of their income. They prefer to lend to someone than someone who has a guaranteed constant income from month to month, to someone who sporadically receives $50,000 in one month, $45,000 in another, for example, and so on throughout the year, but not able to demonstrate a constant income from month to month.

A lender will typically ask your employer for a letter stating your job stability, such as holding a permanent full-time position.

What the Financial Institution is looking for is making sure you will easily make the payments during the lifetime of the mortgage. They would never want to put a client in a situation where income becomes a challenge, and therefore making mortgage payments becomes a challenge as well. Defaulting on a mortgage is a huge burden on the borrower and the lender. Although the lender is using the house as collateral, the lender wants to make sure that you will have many happy years ahead of you with no trouble paying the mortgage.

Fifth: Type of Employment

Seen this way, the next thing a Financial Institution will ask is: How does your type of employment affect your mortgage application? For this, the jobs are classified as follows:

1. Permanent full-time employees.

This is perhaps the easiest job to verify, as your income is permanently guaranteed full time and your salary is the same from paycheck to paycheck. Usually for this, a lender will want a pay stub and a let