Published: October 24, 2018 • Last updated: January 5, 2021 at 18:27 pm
7 Factors that Affect Your Mortgage Pre-approval…and Final Approval
All realtors want their clients to be pre-approved prior to house hunting, and all buyers should want the same thing. This is true even though there is never, ever a sure thing with pre-approvals – since buyer circumstances can change or maybe the property being purchased will not be up to snuff.
In Canada, a mortgage pre-approval is a process of “vetting” the borrower by the mortgage lender to give them an estimate of how much they can spend on a home, the mortgage rate for the first term and the monthly payment they’ll be committing to.
For both pre-approvals and final approvals, there are 7 factors that matter: (click on the factor below to jump to the detailed explanation)
- Your employment circumstances
- Your other financial obligations
- Your credit history
- Your down payment
- Your other real estate holdings (direct or indirect)
- Is your mortgage high ratio or conventional?
- Your mortgage specifics
1. Your employment circumstances
- Is your employment full- or part-time? If part-time, how long have you been doing this, and how many hours are you guaranteed each week?
- Is part of your income earned from commissions or tips? This can make the whole process a bit iffy. Ask your mortgage specialist.
- How long have you been employed, and how stable is your employment? In fact, if you are on probation when you apply for a mortgage, you will find your income will probably not be included in the calculations. That can be an unwelcome surprise.
- Are you self-employed? The sad truth is lenders are more tentative towards self- employed borrowers. But having said that, if you fit into one of their special lending programs (like a “stated income” program) you might find you will be approved for more than you would expect. It’s complex, ask your mortgage specialist.
2. Your other financial obligations
- Do you have any credit card balances? Unless you undertake to pay them off prior to closing, your debt service ratios will increase, and your eligible mortgage amount may decrease.
- Do you have a monthly car, student loan, installment loan or RRSP loan payment? These obligations can affect and may reduce the amount of mortgage you qualify for.
- Are you divorced or separated? Your child or spousal support obligations may negatively impact your mortgage approval.
- Have you co-signed for someone’s car, student loan or even their mortgage? Your lender will calculate your mortgage eligibility as if these are your direct responsibility, even if you have nothing to do with servicing these debts.
- Are you financing a large home? Estimated heating costs are included in debt service ratio calculations, and lenders make adjustments to the number of monthly heating costs they will assign to your property. The days are long gone when lenders allowed us to estimate $75 for any property, regardless of size.
- Are you financing a condo? Their monthly maintenance fees (fifty percent thereof) are included in the debt service ratio calculations, and the amount of mortgage you will qualify for is less than if you are financing a freehold home.
- Are your heating costs included in your condo maintenance fees? Some are not, and this also affects the amount of mortgage you will qualify for.
- Are you collecting Child Tax Benefits? If your kids are less than thirteen years old, there are a few lenders who will allow us to include some of this money in your income. This can have the effect of increasing the amount of mortgage you qualify for.
- Similarly, if you are receiving child support or spousal support, this may too have the effect of increasing the amount of mortgage you qualify for. It depends very much on your specifics, and each case is assessed on its own merits.
3. Your credit history
- For how long can you demonstrate an excellent credit history? Say your credit report consists of only one credit card which you got just last year; your mortgage lender may decline your application.
- How many trade lines are being reported on your credit report? Some people don’t believe in credit “it’s the devil’s work”. Good luck to them securing a mortgage. Lenders want to see you can demonstrate the responsible use of available credit.
- How high is your credit score? If you are in the world of “A lenders”, normally acceptable debt service ratios are 39% for your Gross Debt Service ratio, and 44% for your Total Debt Service ratio.
- Interestingly, if your credit history or personal income is more suited to a “B-Lender”, you might find you qualify for a larger mortgage, since some alternative lenders will allow as much as a 50% Total Debt Service Ratio.
- Debt service ratios are standard measures of one’s “ability to pay” (Canadian Mortgage Trends)
4. Your down payment
- Every home purchase requires a down payment. This can be as little as 5% of the purchase price in some cases.If your down payment is less than 20% of the purchase price, you have a “high ratio mortgage, and are subject to special rules and guidelines. Your mortgage amortization period cannot exceed 25 years. And you will be charged a mortgage default insurance premium, which is typically added on top of your mortgage loan amount.If your down payment is greater than 20%, you have a “conventional mortgage”. There are still rules and guidelines, but sometimes we can request exceptions to the rules because you have “more skin in the game”And your amortization period can go as long as thirty years which equates to lower mortgage payments.
5. Your other real estate holdings (direct or indirect)
- If you have co-signed for someone’s mortgage (typically that is a family member) your borrowing power may be significantly impaired. If you own rental property, you will need to disclose all pertinent details of this property.
- Lenders take differing approaches to the treatment of rental income and expenses when calculating your debt service ratios. You can be sure these properties will affect your mortgage eligibility to some extent.
- Similarly, if you own a second home, like a vacation cottage or pied-à-terre, this will also factor into your mortgage eligibility.
Rental offsets and add-backs can be a confusing topic, but they do have to be considered when applying for a new mortgage.
6. Is your mortgage high ratio or conventional?
- If your mortgage is hi-ratio, your lender is going to need default insurance on your mortgage, and the final word on your approval will be with the mortgage insurer. (CMHC, Genworth, or Canada Guaranty)
- And did you know many lenders will also insure conventional mortgages behind the scenes? (You won’t necessarily be aware, as they are not passing the cost of the insurance premium onto you) In such cases, your mortgage eligibility is subject to their blessing too.
7. Your mortgage specifics
- If you want to have a variable rate mortgage, your maximum mortgage amount will be calculated based on using the Bank of Canada qualifying rate. At the time of this update, it is 4.79% but these things change so please double check before you proceed.
- If you choose a fixed-rate mortgage, your maximum mortgage amount will be calculated based on the GREATER OF 2% more than the mortgage contract rate you choose, or the Bank of Canada Qualifying rate. As a result, more often than not these days, a variable rate mortgage selection might slightly increase your purchasing power.
- The longer your amortization period, the lower your monthly mortgage payment. Ergo, the more mortgage you may qualify for. That said, if your mortgage is hi-ratio, or insured or both, the maximum mortgage amortization period is 25 years. Otherwise, you can go up to 30 years.
These seven factors affect your mortgage approval, and this list is probably not even exhaustive. The more I write, the more factors I think of. So unless you feel your personal finances are so strong that this discussion does not apply to you, you should consult a mortgage specialist in advance of making a major mortgage decision. Also, read the case studies below to see what may go wrong.
How Long is a Mortgage Pre-approval Good For?
A pre-approval is granted based on your financial, employment, credit and life circumstances at the exact moment in time you asked. It stands to reason that if something significant changes between then and the time you actually make an offer to purchase, your approval could very well fly out the window!
But we still see this sort of thing all the time. I guess no one is telling prospective home buyers this hugely important fact.
We present 3 case studies to illustrate (click on the case study to jump directly to the story of interest):
- Case Study 1: Employment changes
- Case Study 2: Changes in debt to service ratio
- Case Study 3: Pre-approval does not last forever
Case Study 1: Employment Changes
Edib and Jana are planning to move up to a bigger house in the next few months. When they went to their bank a couple of months ago to understand their options, Andrea had a solid full-time office job making $43,000 per year. Their bank issued a pre-approval certificate good for 180 days.
During the holidays, they decided Andrea should cut back on her work hours to spend more time with their teenage children. She found a great new part-time job five minutes from their home and she resigned her full-time job.
Last week they made an offer on a larger house in their neighbourhood. The offer was accepted, but when they went back to the bank to formalize their mortgage, they found out they no longer qualify for a mortgage.
They had assumed the certificate they got from the bank was all they needed, but these are never guarantees – just a declaration you should be okay if nothing changes in the meantime (and even if there are no changes, the property itself has to pass muster).
They came to me looking for a miracle, but there are no miracles here. If they want to buy a larger home, Andrea will need to restore her employment and income to roughly what it was when the bank pre-approved them.
Similarly, a family of three (parents plus adult daughter) decided last Fall to buy a home and were pre-approved by their bank. The daughter went back to school full time in January and was surprised to learn their pre-approval was no longer valid. A pre-approval is never binding on the lender – EVER!
In another example, one of our clients last year quit her full time consulting job to become a self-employed contractor AFTER her mortgage request was approved. She had waived all conditions and was committed to buying a new home in King City, and assumed that once she was approved it would be plain sailing.
Not the case. Mortgage lenders often wait to confirm employment in the last week prior to closing. This turned out to be a disaster – she was not able to close and now is being sued by the seller.
Case Study 2: Changes in Debt to Service Ratio
Other times we meet buyers who take out a new car loan or lease after they are pre-approved. This changes their Total Debt Service Ratio (TDSR) and may make the difference between remaining approved or being disqualified.
Last summer a couple we pre-qualified came back with an offer to purchase in the Fall. We always have to submit a fresh copy of the credit report with an application (fresh means less than 30 days old) In this case, they had each recently binged on applying for new credit with several credit card issuers. This raises red flags.
Upon further discussion, it turns out their expected gifted down payment had fallen through, so they decided to apply for credit and use borrowed money to fund the down payment. This does not spell an automatic decline – but in their case it did, since the monthly payments on their new credit cards killed their TDSR.
If you are planning to buy a new home, and you are considering making changes to your income, employment or financial circumstances, do not assume that because you were pre-approved previously that you are good to go. You’re probably not.
Case Study 3: Pre-approval Does Not Last Forever
Of course, we all know that nothing lasts forever (sigh), but no one wants to find out that the timer on their pre-approval is about to expire, and with it, a much preferred lower interest rate.
We received an anxious call this week from a realtor partner whose client is distraught over his mortgage pre-approval with a major chartered bank. Four months ago, they secured a pre-approval for an $800,000 mortgage at a really low fixed rate for two years, and he did not realize it would expire this week.
His buyers have finally found a property they wish to buy and when they contacted the bank to share their good news, they were told their rate is no longer available. If they want the same mortgage now, the going rate is 0.6% higher.
Their monthly payment will increase by $246…OUCH!
What went wrong?
Typically mortgage pre-approvals hold the interest rate for 120 days. That is usually enough time for buyers to find their ideal home. If you are buying from a builder, with a longer closing period, you can arrange a far longer pre-approval, but the rate will be much higher than the best rates available in the near term.
Our friends’ clients thought that as long as they submitted their final purchase application within 120 days they would be fine. But no, the actual purchase must fund within 120 days. That’s a big difference.
When you consider most offers to purchase close 60 to 90 days after the offer is accepted, then you really only have 30 to 60 days after you secure your pre-approval to find the home you want.
In recent years, this would not have been a big deal, as mortgage rates have been at record lows for quite some time. But since August of 2017, the Bank of Canada has raised its overnight rate four times already, with more increases in the forecast before year-end.
Along with this came mortgage rate increases. For example, five-year fixed mortgage rates have actually increased by more than 1% in the past year.
What could have been done?
Mortgage brokers typically know about pending rate increases before anyone else. And often they are given a friendly warning that their lenders are planning to increase their rates at midnight that night.
At Ross Taylor & Associates we notified all of our pre-approval clients who we thought might be affected, and suggested they either step up their buying efforts, or we re-apply for a mortgage pre-approval and reset the clock to a new 120 day period.
Had this been done here, our friends’ clients would have opted for a new pre-approval which would have neatly extended their rate hold-out three months beyond where it currently sat.
Closing Thoughts – 3 Key Benefits of Getting Pre-approved
More than ever, a mortgage pre-approval just makes sense. Even though a pre-approval is not a guarantee the lender will come through when you have an actual purchase, there are many benefits.
- Protect yourself from further interest rate increases for the next 90 to 120 days. At the very least you will pay no more than the rate on your pre-approval certificate, and if your lender’s rates are lower when you have a live purchase, you will enjoy the lower rate.
- Having a mortgage pre-approval certificate allows you and your real estate agent to stand out from other offers in a crowded purchase process. Even if you ask for a short (say 2 days) condition of financing clause, the seller will take great comfort from your certificate, and will be less inclined to think they are wasting precious days holding your offer.
- Being pre-approved gives you a clear idea of how much mortgage you will actually be approved for. With the introduction of stress testing mortgage applications as well as tiered mortgage rates, depending on your borrower profile, this is more important than ever and also harder to predict than at any time previously.
You can read just one of the many success stories here.