Mortgage Qualification Tutorial

This tutorial will give you an idea of what to expect based on traditional guidelines. Remember that these are just guidelines and everyone’s situation is unique. If it appears that you may not qualify for the amount of mortgage you require, speak to your agent to identify if this is truly the case and what options may be available to you. To pre-qualify for a mortgage, there are three essential components: income, equity, and credit. Over the years, qualification guidelines have become fairly standard within the lending industry. While each institution may have some unique criteria, the basic qualifying criteria are the same. The following section will explain the basic requirements for mortgage approval.

INCOME

What is classified as income for qualifying purposes? Some forms of income that represent revenue to your household may not count as income for qualification purposes. The important thing when it comes to income is to demonstrate consistency and sustainability. Here are some of the many sources of income and some of the guidelines for using them to qualify for a mortgage:

Employment income -If you are an employee of a company or corporation, the basic guideline for income eligibility is that you have been employed for one year with the same employer or at least one year in the same line of work with no probationary period on the new employment.

Probation period - If you are with a new company and you are still within a probationary period you may have some difficulty using this income for qualifying purposes. However, there are certainly lots of cases where individuals on probation have still been considered for mortgage financing.

Overtime -If you want to use overtime for your qualifying income, most lenders will want to see a consistent history. Typically, you will be required to provide a two-year track record of your overtime income.

Seasonal income -This is acceptable, but you will likely be required to demonstrate sustainability by providing a two or three year track record. Usually an average of income over these years will be used for qualifying purposes.

Self-employed -If you are self-employed, you can still qualify, but most lenders will require a track record of consistent income. The standard is a two year average of your net taxable income. Lenders do recognize that many self-employed individuals will make legitimate tax deductions in order to reduce their taxable income. If you don’t pay taxes on the income, the lenders will most likely not accept anymore then the net declared income. A trained mortgage professional should be able to review your financial statements and find items that may be allowed to be 'added back' into your income.

Pension income -Guaranteed pension incomes are usually acceptable sources of income. Your best bet is to have a thorough discussion with your mortgage broker so they can advise you of acceptable income.

Child tax credit -Some lenders may consider this income. Ask your mortgage professional about which lenders will allow this if this is income you would like to have considered with your mortgage application.

DEBT RATIO

The amount of mortgage you may qualify for depends on two things: income and the amount of debt you are carrying. Financial institutions use two different ratios to measure your borrowing ability. The first is your Gross Debt Service Ratio (GDSR). The second is your Total Debt Service Ratio (TDSR).

Gross Debt Service Ratio

Your GDSR is the percentage of your gross monthly income that is used toward your housing expenses. The expenses used in this calculation are Principal and Interest payments, Tax instalments and Heating costs, plus half your monthly condo fees, if applicable. The following is an example of a GDSR calculation assuming a $150,000 mortgage with monthly payments of $925.59 based on a 25-year amortization.

Principal and Interest       $925.59
Heat                                  $75.00
Taxes                                $125.00
Total for debt service       $1115.59
Gross Monthly Income     $3500.00
GDS Ratio calculation      $1115.59/$3500.00 = .318 or 31.8%

In the above example, the homeowner is spending 31.8% of their household income on housing expenditures.

To qualify for a mortgage, traditionally, most lenders require that your GDSR be below 32%. As of October 2006, lending practices now allow a GDSR of up to 35% and in circumstances where a borrower’s credit is exceptionally strong, may allow for a GDSR of up to 44%.  This coupled with the option of extended amortizations, significantly increases consumers borrowing power.

Total Debt Service Ratio

Your TDSR is the percentage of your gross monthly income that is used towards your housing expenses plus your other monthly obligations. The expenses used in this calculation are principal and interest, taxes and heat plus half your monthly condo fees, if applicable, plus student loan payments, credit card payments and car loan payments, etc. The following is an example of a TDSR calculation assuming a $150,000 mortgage with monthly payments of $1115.59.

Principal and Interest       $1115.59
Heat                                  $75.00
Taxes                                $125.00
Car Loan                           $200.00
Credit Card Payments      $50.00
Total for debt service        $1565.59
Gross Monthly Income      $3500.00
GDS Ratio calculation       $1565.59 / $3500 = .4473 or 44.73%

In the above example, the homeowner is spending 44.73% of their household income on housing expenditures and other debt.

In order to qualify for a mortgage, traditionally lenders have required that your TDSR be below 40%. Since October of 2006, lenders can process and approve up to 42% TDSR. In the case where a borrower has exceptional credit, the lender may allow for a TDSR of up to 44%.

CREDIT

Credit is a critical component but is also one of the easiest to improve, given time. If you do not know your credit status, review your credit report to learn more and ensure accuracy.

What is a Credit Report?

A credit report is a history of how consistent you have been at meeting your financial obligations. A credit report is created when you first borrow money or apply for credit. On a regular basis, the companies that lend money or issue credit cards to you (banks, finance companies, credit unions, retailers, etc.) send the credit reporting agencies specific and factual information about their financial relationship with you including: when you opened the account, if you make your payments on time, if you have missed payments or have exceeded your credit limit. Credit bureaus receive this information directly from the financial and retail institutions and report it. They do this to assist new, inquiring lenders in making decisions about granting you credit. Your credit report is a history that will help lenders determine what kind of lending risk you are and how likely you are to repay your obligation on time.

What is a Credit Bureau?

A credit bureau is a private, for-profit business that gathers and reports your credit information, for a fee, to whomever has been given permission to request it. There are two major consumer credit bureaus in Canada, Equifax and Trans Union.

What is reported?
Personal identification: Name, address, date of birth and Social Insurance Number (SIN).
Consumer statement: Allows the consumer to add a brief comment about any information in the report.
Credit information: Details of credit accounts, transactions and history of late payments.
Public record information: Secured loans, bankruptcies and/or judgments.
Third-party collections: Any involvement with a collection agency trying to collect on a debt.
Inquiries: All organizations or individuals that have requested a copy of the credit report in the past three years.

What is a credit rating?

A credit rating for each trade item is reported on your credit report as well as an overall credit score. Ratings range from 1 to 9 (one being the best rating and 9 being the worst). Your credit score is a statistical formula that translates personal information from your credit report and other sources into a three-digit score. In order to understand how your credit is scored, contact one of the credit reporting bureaus or you can request more details from your mortgage professional.

Improving your credit score

Pay all of your bills on time. Paying late, or having your account sent to a collection agency, has a negative impact on your credit score.

Do not run your balances up to your credit limit. Keeping your account balances below 75% of your available credit may also help your score.

Avoid applying for credit unless you have a genuine need for a new account. Too many inquiries in a short period of time can sometimes be interpreted as a sign that you are opening numerous credit accounts due to financial difficulties, or overextending yourself by taking on more debt than you can actually repay. A flurry of inquiries will prompt most lenders to ask you why. Most scoring formulas will not penalize you if, for example, you are shopping for the best rate on a mortgage or car loan.

Rebuilding your credit
The best place to start rebuilding your credit is through a secured credit card. In order to re-establish your credit you need to have some creditors report that you are paying as agreed. In time, these new current accounts will help rebuild your rating. Your mortgage professional can provide you with a secured Visa application to get you started.

Where can you view your credit report?
There are two sources of credit reports: Equifax and Trans Union.

Improving your current situation
If you find that we are temporarily unable to qualify you for the mortgage amount you require, there are steps you can take to improve your situation and possibly increase the amount that you may qualify for in a short period of time. The first step is to identify the obstacles to approval and to pinpoint the areas that need improvement. From there, we can develop a plan to overcome those hurdles. Here are some tips for improving common roadblocks when it comes to mortgage approval.

Income and Debt: If your debt ratios are the problem, there are two options for you: increase your income or reduce your debt. One way to increase your income may be with the assistance of a co-signer. By having someone co-sign for you, you may be able to include their income when calculating the debt service ratios.

Credit: Ensure that you always make, at least, the minimum payment on all of your bills. Every late payment that is recorded on your credit bureau report has a negative impact on your rating. If you are still having trouble, credit-counselling services can also be of assistance when trying to repair or rebuild your credit.

Down Payment:  Recent changes to Mortgage Loan Insurance have reduced the barriers to home ownership with respect to down payment. Ask your mortgage professional if these changes may benefit you. A good household budget coupled with a strong savings plan is one of the best ways of saving for a down payment. You may also be able to use your RRSP as a savings vehicle. If you are a first time homebuyer, you may be eligible to use up to $20,000 of RRSP savings toward the purchase of a new home under the Home Buyers Plan™ (HBP). By saving through your RRSP, you also receive a tax deduction that may give you a refund at tax time allowing you to add even more to your down payment savings pool. The Home Buyers Plan™ is a program that allows you to withdraw up to $20,000 from your registered retirement savings plan to buy or build a qualifying home for yourself. See our RRSP and HBP section for more information and direct links.