An Introduction to Borrowing Money For a Home Purchase
Very few first-time buyers pay for their home outright. Most need loan financing to pull it all together. First, you save up the down payment (no less than 5% of the purchase price) and you borrow the rest with a mortgage.
What is a mortgage anyway?
A mortgage is a loan used for real estate transactions in which the property is collateral for the loan. If you don’t make the payments, the bank/lender can seize ownership of the property.
Because mortgages entail a large amount of money and are backed by a physical asset, they allow most people to borrow money at a relatively low-interest rate and spread the payments out over a long period of time (the amortization period). The interest rate can (and typically does) change over the life of the loan, but is fixed for a specific term, typically five years.
No mortgage – no home
Let’s first make sure you are strong enough to qualify for a mortgage. If you can’t do that, then nothing else matters. (Unless of course you can afford the home outright and do not need financing.)
What do lenders want to see?
Lenders primarily care about 4 factors when making a decision about whether or not you are qualified for a mortgage (click on the factor to jump directly to the detailed explanation):
- Employment and income history
- Credit history
- Your available funds to make a down payment and cover closing costs
- What are you buying, and where is it located?
1. Employment and Income History. Lenders need to know whether you are you in a stable job or are you still under probation? How much gross income do you make, and how does that compare against a possible monthly payment for your mortgage, property taxes, utilities, and perhaps condo fees?
They also assess any other monthly obligations you may have – like student loans, car and credit card payments, etc. They want to be sure you can cover these too.
2. Credit History. Have you have demonstrated an ability and established a track record to manage credit responsibly? Ironically, if you have managed till now with no credit cards, or maybe one little one, you will not be nearly as attractive to the lenders as someone who has been around the block more.
They want to see that even when you have credit available to you (from several sources); you can handle it and manage it just fine.
I cannot overstate the importance of strong credit history. When your credit score rocks – like 750 or more, lenders are looking for ways to make this deal work – as opposed to finding excuses to shy away from it.
If these two data points don’t get you there on your own we may still be able to make it work, but your application may just need a helping hand in the form of a guarantor or co-signer – someone more established who is willing to show their faith in you and guarantee you will honour a mortgage commitment.
3. Available funds to make the down payment and cover the closing costs. The minimum down payment these days is at least 5% of the purchase price. (More if the price exceeds $500,000.)
You must demonstrate you have saved up this money – or that you will be gifted the money from a relative. (Note gifted – not loaned.)
For closing costs, lenders typically want to see you have 1.5% of the purchase price – so on a $600,000 home, they want to see $9,000 set aside.
Whenever proof of account ownership is required, your lender will often need a 90-day history of the funds.
4. What are you buying and where it is located? Some locations are too remote. Some homes are too run down. God forbid you unwittingly buy a grow-op house!
So are you ready for a mortgage?
You can ask your mortgage broker to see if you would qualify for a mortgage in the price range you are thinking of. People refer to this as a pre-approval. Be careful here – the truth is a pre-approval is not a cast-iron contract. And it is pre-approving you, not the property you may end up trying to buy.
But it’s definitely worth something – if your broker says no way you are ready, you can be pretty sure you are not. And you will learn what you still have to do to get ready for prime time and when that will be.
- First Time Home Buyers Ontario: Everything You Need To Buy Your First Home
- What Type of Mortgage Is Right For You?
- Why You Need A Down Payment Strategy
- Good Credit Hygiene Saves Over $100K On Typical Mortgage
- Explain Mortgage Amortization Period and Term
- Why Is My Mortgage Application Declined?
- Important Factors In Selecting Your Mortgage
- Mortgage Pre-Approval in Canada: What It Is & How To Get It
One of Toronto/GTA's Most Trusted and Knowledgable Mortgage Agents
Ross Taylor is recognized by his peers as one of Canada's pre-eminent difficult mortgage specialists. His ASKROSS blog and column in Canadian Mortgage Trends are focused on the intersection between mortgage financing and personal credit.
With unique dual certification as a licensed credit counselor and mortgage agent, Ross's insights are valued by mortgage professionals and homebuyers alike.
If you have questions about anything financial or mortgage-related, please contact [email protected]. Ross answers everyone personally.
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