Qualifying for a Mortgage: The 4 Factors Lenders Consider
Picture this: after months of searching, you find your dream home, so you make an offer and it’s accepted. Congrats, you can finally call yourself a homeowner! Well, not quite yet. I hate to burst your bubble, but unless you can afford to pay for the home in cash, you’ll need to take out a mortgage. If this is your first time applying for a mortgage, you’re probably curious about how the mortgage approval process works. Let’s look at the four main factors lenders look at to qualify you for a mortgage.
- Your Income
A mortgage is a lot of money, even for the banks. Banks won’t just approve a mortgage application for anyone who comes in off the street. Ideally, they’re looking for a borrowers with steady income in the last two years (a salaried employee). If you’re a small business owner or work on contact, it will be harder to qualify for a mortgage. You’ll want to find a lender who specializes in mortgages in those areas.
That being said, the more income you earn, the easier it will be for you to qualify for a mortgage. If you’re purchasing a home in an expensive real estate market like Vancouver or Toronto, earning a higher wage will certainly help your mortgage application.
If you aren’t qualifying for the home purchase price you hope, it helps to buy a home with a partner – either a romantic partner, family member or friend. With two incomes or more, you’ll have an easier time qualifying for a mortgage to buy your dream home.
- Your Down Payment
Just like your income, the bigger your down payment, the easier it will be for you to qualify for a mortgage. In a perfect world, everyone would have a 20 percent down payment, but that’s not always possible. In expensive housing markets, even coming up with a five or 10 percent down payment can be tough.
If you can’t come up with a 20 percent down, try to save a 10 percent down payment (if you’re buying a home with a purchase price between $500,000 and $999,000 you’ll be required to save a 10 percent down payment on the portion of the purchase price over $500,000). Not only will your mortgage be smaller, helping you save on mortgage interest, you’ll save on mortgage default insurance, too.
How can you come up with a bigger down payment? By earning more income or cutting expenses. To earn more income, you could take on a side hustle. For example, you could housesit, walk dogs or consult in your free time. Ways to cut expenses include taking public transit instead of your car to work, cutting back on your daily trips for coffee and packing your lunch more often. If you’re able to save even $25 or $50 a month, it will go a long way in reaching your down payment goal sooner.
- How Much Debt You Have
Besides how much money you earn and how much money you have in the bank for your down payment, the banks also are concerned about your personal debt situation. And this makes absolute sense. If you have a lot of debt – credit card debt, a car loan and student debt – it can be challenging to afford mortgage payments to top it all off.
Lenders use two main debt ratios to qualify you for a mortgage: the gross debt service ratio and total debt service ratio. With most lenders you’ll need to meet the minimum thresholds set by the lender. Sometimes they’re willing to waive one of the debt ratios, but that’s up to the individual lender and they may only be willing to do that if you have a strong mortgage application on paper (i.e. you have a sizable down payment or steady income.)
- Your Credit History
The last factor lenders consider is your credit history. Lenders look at this in two ways: your credit score and credit report. Your credit score is a three digit number assigned to you by the credit bureaus (Equifax and TransUnion). Credit scores typically fall between 300 and 900 (the higher the better). If you have a credit score of 700 or above, you shouldn’t have any trouble qualifying for a mortgage.
A good credit score goes a long way. It indicates that you use credit responsibly (i.e. you pay your bills on time and in full). It can also help you with qualifying for a mortgage and helps you get the best mortgage rate. If your credit score isn’t so great, you could have to pay a higher mortgage rate or your mortgage application could be denied by schedule A lenders, so you might have to go with alternative lenders with higher mortgage rates.
To avoid any nasty surprises, get in the habit of reviewing your credit report and credit score once every six months. You’ll want to review it before you apply for a mortgage in case there are any issues. This will give you sufficient time to clear them up, so you can make the strongest mortgage application possible.
Disclaimer: Contact a mortgage professional to see if the strategies mentioned apply to your specific situation.
You may also be interested in: What You Need to Know About the New Mortgage Stress Test
Writer: Sean Cooper
Sean Cooper bought his first house when he was just 27 and paid off his mortgage at 30 in 3 years. An in-demand personal finance journalist, money coach and speaker, his articles have been featured in publications such as the Toronto Star, Globe and Mail, MoneySense and Tangerine’s Forward Thinking blog. He makes regular appearances on national radio and television shows to discuss personal finance, real estate and mortgages. He’s also the bestselling author of the book, Burn Your Mortgage, which helps anyone—from new buyers to experienced homeowners—achieve the
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