Lenders use four main factors to assess their willingness to approve a mortgage application, especially for first-time buyers. We at Kelleway Mortgage Architects know a wide variety of lender policies in detail and how they relate to these factors. Therefore, our clients benefit from our wealth of knowledge and expertise when we help them mortgage it right.
Four main factors that lenders use to determine the credit worthiness of borrowers are:
(i.e., what is the quality of the security?)
(i.e., can the borrowers afford to pay back the mortgage?)
(i.e., what if the borrowers do not pay back the mortgage?)
4. Credit History
(i.e., how well have the borrowers paid their debts in the past?)
If the property does not pass certain buying criteria (e.g., a positive home inspection), then the borrower may refuse to remove subjects and thus cancel the purchase agreement with the seller. Along the same lines, if a property does not pass certain lending criteria (e.g., property is located on a flood plain or the building is identified as "leaky"), then the lender may not approve the mortgage for funding.
The quality of the client's income depends on the stability and amount. (See employee vs. self-employed info on the CRA website
Lenders usually consider borrowers who are employees as having more stable income than those who are self-employed. For example, an employee receiving a base salary may be required to submit only a recent pay statement and job letter to verify his or her income. Employees who received their income in commissions may need to supply further documentation such as the income declared on their last two years of Notice of Assessments (NOA's) which are issued by the Canada Revenue Agency.
The lenders' guidelines determine how much of the borrower(s)' PRETAX income they will allow to cover the borrower(s)' regular monthly costs. Costs include, but are not limited to, (mortgage payment + property taxes + strata fees, if applicable) and other debts (credit cards, car/student loans). These monthly costs are used by the lenders to calculate Debt Service Ratios.
The two most common debt service ratios are the Gross Debt Service (GDS) and Total Debt Service (TDS).
GDS = Housing costs / Pretax Income
TDS = Housing costs & other debts/ Pretax Income
Generally, we like our clients to qualify for a mortgage with a maximum GDS at 32% and a maximum TDS at 40%. However, some Lenders will stretch GDS to 39% and TDS to 43% based on their lending criteria for specific mortgage products and based on the applicant's credit worthiness.
Generally, the debt service relationship means that:
1. the higher your income, the more you can borrow, and
2. the more monthly payments you carry, the less you can borrow.
The downpayment is the amount the borrowers' will invest of their own money as equity in the property. The higher the borrower's equity, the stronger the mortgage application appears to the lender. The lender assesses risk by considering the amount of money both they and the borrowers will lose if regular mortgage payments are not made and a foreclosure results. Lenders feel more confident that the mortgage will be repaid when the borrower has a substantial amount of money at stake.
The ratio the lender's use in regards to equity is called the LTV (Loan to Value).
LTV = Amount of the mortgage / Purchase Price
If the Loan to Value (LTV) on the property is above 80%, the lender is required by government regulation to have default insurance on the mortgage. This default insurance protects the lender against borrower default. The default insurance premium is the borrower's responsibility and is usually added into the mortgage amount.
The default insurance premium depends on the loan amount and the LTV.
Please note: Default insurance is DIFFERENT from mortgage insurance, as the default insurance is for the lender's benefit (not the borrowers').
There are currently two default insurance providers in Canada:
- CMHC (Canada Mortgage and Housing Corporation)
- Genworth Financial
Some lenders use one default insurance provider exclusively, while others use more than one.
Finally, some lender products and programs are restricted by the LTV.
A client's credit history is usually determined by his or her credit bureau. All mortgage applications will require the mortgage broker/lender to pull the intended borrower's credit bureau.
The credit bureau includes information on the following:
- The client's beacon score (this is calculated by some obscure formula by the credit bureau)
- List of the client's current and past credit accounts (this includes the credit cards and loans) and how regular the client has been in making payments
- Any collections or judgements filed against the client
The beacon score ranges from 0 - 900+
For lenders, a good beacon score is around the 650+ range. Scores above 680+ are considered excellent as they allow more flexibility for the client with regard to the GDS requirement.
Some of the factors that affect the beacon score are:
- Payment History
- Amounts owed
- Length of credit history
- Number of Recent Inquiries
How well you have kept up to date with your account payments. Paying your bills on time is the most important factor in having a good credit score.
How much balance owing you have in relation to the account limits. The higher the balance, the more negatively this affects your credit score. It is prudent to keep your balances at or below 50% of the credit limit.
Length of Credit History
The longer you have established your credit history, the better. Lenders normally require two years credit history; otherwise, they may require a guarantor.
Number of Recent Inquiries
Your beacon score is negatively affected if there are too many recent inquiries within a short period of time (having four inquiries in one month is an example). This does not apply if you inquire on your own credit bureau (rather than have the lender inquire on you).
How these criteria affect your borrowing options:
These four factors (i.e., Property, Income, Downpayment and Credit History) all contribute to the strength of a client's mortgage application. Think of it as a house with four supporting columns. One column may be a bit weaker. However, as long as it's offset by the strength of the other three columns, the lenders will usually have a mortgage product available.
In today's market, despite government and lenders tightening some lending policies, there is still a wide aray of lending products available....if you know where to look....and we do!
A) Property - acceptable to lender
Income - weak
Downpayment - strong
Credit History - strong
= flexible income mortgage products
B) Property - acceptable to lender
Income - strong
Downpayment - weak
Credit History - strong
= High-ratio financing
C) Property - acceptable to lender
Income - strong
Downpayment - strong
Credit History - weak
= Alternative or B-lending
(or lending on an exception, depending on the circumstances)
D) Property - borderline quality but expected to improve with renovation or new construction
Income - strong
Downpayment - strong
Credit History -strong
= Purchase + Improvements Mortgage or Construction Loan
In some cases, a lender will not accept a client's mortgage application based upon the strength of the above factors. For example, the client may be a recent post-secondary graduate who is just starting a new job and is depending on his/her parents giving him/her a large portion of the downpayment. In those cases, lenders will consider the client adding co-signers or guarantors to the mortgage application in order to make it more acceptable.
Co-signer. A co-signer (also known as a co-applicant or co-borrower) is on both the title of the property and on the mortgage.
Guarantor. A guarantor is not on the title of the property but is on the mortgage. In some cases, one person may have a spousal guarantor in order to preserve the spouse's First Time Home Buyer Grant for a future purchase of a home. Some lenders will consider this setup.
Other items of Interest for First-Time Buyers:
Home Buyer's Plan
The Home Buyer's Plan is a Canada Revenue Agency (CRA) program that allows an individual to withdraw up to $ 20,000 from his/her RRSP's without having to pay taxes on that amount.
This means that for 2 people, you can withdraw up to $ 40,000 combined.
First Time Home Buyer's Program
The First Time Home Buyer Program is a British Columbia government program that exempts first time home buyers from paying the Property Transfer Tax within purchase price thresholds.
Please note that these two programs have a different definition of "First Time Home Buyer"
"Home Buyer's Plan"
- Must not have owned a home that you occupied as a principal residence beginning January 1 of the fourth year before the year of the RRSP withdrawal.
"First Time Home Buyer's Program"
- Have never owned an interest in a principal residence anywhere in the world at anytime
There are a few other conditions that must be met in order to qualify for these programs.
More information can be found at the following websites:
Home Buyer's Plan: http://www.cra-arc.gc.ca/tax/individuals/topics/rrsp/hbp/conditions/first-e.html
First Time Home Buyer's Programhttp://www.rev.gov.bc.ca/documents_library/brochures/FirstTimeHomeBuyer.pdf
Kelleway Mortgage Architects
*Subject to approved credit, income verification and meeting lending credit granting criterea. Applies to residential mortgages only and some conditions may apply. O.A.C., E.O.E All content is subject to change without notice.