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 letter from your employer to confirm your permanent full-time status.
2. Salary plus bonus or commission.
If you've been with the same employer for at least two years and have received a bonus or commission for at least two years, the lender will typically use your base annual income, plus an average of the bonus or commission over the past two years. If you are new to the bonus or commission, a lender will generally only use the base salary.
Also, if you are new to the employer, the lender will only use the base salary. In this situation, they will ask for a pay stub, as well as a letter from their employer detailing their base annual income and the bonus structure.
3. Contract for external employees (Freelance Employment)
For those with a contract, the lender must see a two-year tenure with the current employer. This can create challenges for those who are new to the world of work. The lender's goal is to see not only your tenure but also your average income over the past two years. If you are considering buying a home and switching jobs to one under a temporary contract, it would be best to speak with a mortgage broker first to discuss how the challenges that this decision will pose can be avoided.
4. Part-time job
Part-time employment is perfectly acceptable for a lender as long as it is permanent part-time employment. A lender will ask for a letter from your employer stating your annual income. Additionally, they will require a current pay stub. If your part-time employment is not guaranteed, a lender may not be able to use this income on the application.
5. Hourly employment
For hourly employees, a lender typically looks at an average of your earnings from the last two years with that same employer. If you do not have tenure for two years, the lender will typically look for your guaranteed minimum wage and hours. If there are no guaranteed minimum hours and you do not have a two-year tenure, a lender may not be able to accept this income in an application.
6. Trial period
Most lenders cannot accept income from an applicant who is not guaranteed job tenure. This is the reason why an income letter is generally required for all jobs where there is an employer, as they want to see if you are permanent or may soon be unemployed by virtue of the trial period has ended. If you are in this situation, it is best to set a closing date for your sale and purchase after your trial period ends when the employer can offer you a permanent contract.
7. Casual and temporary employment
There are many casual jobs that offer weekends, nights, part-days, or part-time jobs with no tenure. Most of these jobs are in the area of services, hotels, restaurants, shops, and the like. Depending on the company, these positions have different pay, but it is usually the minimum payment.
Generally, the lender cannot use an applicant's job that is not guaranteed. If you are in a temporary position, the lender may not be able to use this income in the application. Depending on your tenure as a contingent employee, the lender may consider using an average of two years if you have been doing that type of work for several years.
8. Self-employment or entrepreneurs
Self-employment is a bit more complex than the above mentioned. The lender's goal is to ensure that there is a pattern of income as well as the potential for future income through self-employment. For that, a lender will look to use a two-year average of your net annual income. There are also programs available to self-employed mortgage applicants in which they can fill in net income or use gross income. A mortgage broker will be able to review these options in detail with you.
6th Criterion, Document the File - Compliance.
Now, the next thing to ask yourself is: What employment documents should you provide when applying for a mortgage? We already went deeply through this topic in Episode 4.
Prior to anything, you should make sure that the mortgage you are applying for aligns with your current work income and your current debts. This affects the debt-to-income ratio that lenders will follow. If your new job has a lower income than your previous job, you may need to reduce the amount of the mortgage you are applying for.
The next step is to show the lender that you have security. The lender will want to see guaranteed hours or a guaranteed income amount at your current position. This is easy to confirm when you are permanently full time with a guaranteed position. However, for those who do not have a guaranteed salary, a lender would like to see their employer's verification of their guaranteed minimum annual income.
Making a larger down payment will help reduce the amount you need to borrow. Also, if you do not qualify for a traditional lender, putting 15-20% can allow you to access mortgage solutions with alternative and private lenders. In addition, by putting 20% or more, you do not have to go through a mortgage insurer (ie: CMHC) which can also offer a more favorable environment to reach the loan. For example, under these conditions, you can go for a payback period of up to 30 years. ￼
As explained in the previous Episodes, having all the documentation ready can help, not only save time but also achieve an accurate review of the lender in advance.
Also, having a mortgage advisor can help you work on a strategy to get your application to obtain the best outcome.
In summary, the strongest ballot in your mortgage application is job stability. The more stable your job is and the more income you contribute to your debt-to-income ratio, the better interest rate you will get on your mortgage and the higher the chance of getting the mortgage approved.
If you can qualify for many different lender options, it will allow you to choose from more options and a better selection of interest rates. This is only achieved through a mortgage advisor, giving you access to 50+ lenders with a single APP.
If you want to form a financial strategy aimed at solving all these issues, as we saw in another article, the Mortgage Broker Advisory Has No Cost for You. They are professionals who pass an examination authorized by the government of Canada, by law they are issued a license with which the Financial Institutions pay them their fees for the loan they fund with them. (see our article on it).
But this does not mean that the value of credit increases; it is the opposite. The mortgage broker will look for the cheapest product on the market that exists among all Financial Institutions, and the one that best suits the needs of each person, so the market for offers, and development of more and better credit products, is the day to day of these Institutions, and the work of the mortgages brokers is to know all these products and criteria mentioned, to favor their clients with the best product in the mortgage market; and this is at no cost to you.
With their advice, you can also get support if you feel like your spending is out of control and you are having a hard time managing your debt burden - go for it. Talk to your mortgage broker today, they can also help you:
Review the ways to eliminate debts
Rebuild and increase credit ratings
Find financing alternatives
Improve cash flow management
Understand the importance of financial education
Having a good credit score equates to being in good financial health, and therefore having a good ability to borrow.
In the next episode of this ABC of Mortgage in Canada series, we will talk about the million-dollar question, What is your Best Mortgage Rate?
We hope this information has been useful to you, and if you think it could be useful to someone else, share the link. You can count on our mortgage advisors during this process. Do not hesitate to visit us:
Thank you for listening to us. Bye!
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