Mortgage Matters: Qualifying for The Mortgage

By Bob Quinlan

Before talking about what it takes to qualify I want to take a step back and remind you of the carrot at the end of the stick.  It is now law that at least 48 prior to signing for a mortgage the lender or broker must inform the client of the cost of credit over the term of the mortgage (cost of interest disclosure).  People usually cringe when they see how much interest they will pay as opposed to the principal paid at the end of the term.  On a $200,000 purchase with $0.00 down you would start owing $207,400.  @ 6.00% (4 year term) you would be paying $1,130.51/month ($54,264.60 in total) and at the end of four years you will still owe the bank $201,661.10.  Yes that is correct.  You have paid $48,525.70 in interest.  And you still owe the bank more than the original price of the house.  However and here is the carrot…if the value of your home was to appreciate at only 5% per year your home would be worth approximately $243,100 at the end of those four years.  That is approximately $42,500 of equity that you now own.  Not bad for starting out with $0.00 down.

Now, what does it take to qualify for a mortgage?  Once again, I will stick to the “A” or chartered bank requirements.  Then Canadian Bank Act allows banks and credit unions to lend up to 80% of the value of a home on their own criteria.  The majority of borrowers and especially first time buyers will have less than 20% down and will need CMHC, GE Capitol or AIG trust to insure the mortgage to the lender.  They charge a onetime fee (3.70% on 100% financing) that is charged to you and added to your mortgage.  If you default they will pay out the lender and then they will come after you.  It is their guidelines we must follow to get you approved. 

First is your credit rating.  Your report card to the lenders.  It consists of how many trade credits, the type of borrowing (loans and/or credit cards), how long you have had them, your ratio of balance to limits and what your history of payments has been.  This will provide them with a credit score.  “AAA” ratings will give you the ability to purchase with $0.00 down.  A lesser credit rating will mean you will need to come up with 5% or more for a down payment.

Secondly is your income.  Is your job stable?  If you have been at the same job for more than two years and extra income via commissions or overtime exceeds your base salary you will have more qualified income to service the debt.  Guaranteed income like pension, child tax credit and disability benefits can also be included.  The more income you qualify with the more that you can use for Gross Debt Servicing and Total Debt Servicing.

The third qualification they calculate is called Gross Debt Servicing and Total Debt Servicing to determine if you can qualify.  Gross Debt Servicing is the percentage of your gross income that can be used to pay your mortgage, heat and property taxes.  At present that limit is 32%.  Total Debt Servicing is the percentage of your income that can be used for your mortgage requirements and the rest of your personal debts (credit cards, loans, etc.)  That limit is 40%.  If your personal debts exceed 8% of your income the excess percentage is deducted from your mortgage limits and that is reduced accordingly.  That is why some people with a lot of personal debt can’t qualify for a very big mortgage.  Sometimes we need to get people to consolidate those personal debts and bring their monthly payments down so they can afford a nicer home.

These calculations will provide the lender the assurance that you can afford to pay for the debt.  Remember, the lender doesn’t want to foreclose on a property; they just want to collect the interest on the debt.  That is their sole form of income.  This is what is known as the covenant.

On the other side of the equation is the security.  What they can rely on if you default on the debt.  Their security is the property and its improvements.  That is why lenders look at different properties differently no matter what the purchase price.  Prime properties are your basic homes in the city on municipal services that can resell in a minute no matter what the market.  Properties that are more difficult to sell are considered to be:  large acreages, mobile homes, smaller communities, and remote locations, less reliable services, larger or even smaller homes.  These are homes that will have restrictions on them the lender might be required to shorten the amortization (total number of years it is expected to take to pay off) period or even lessen the loan to value ratio (increase the down payment).  The amount of the security will be determined by the lesser of the acquisition price or the appraised value.  If you were to pay $200,000 for a home that was appraised at $250,000, the bank would consider the lending value to be $200,000.  If you were to pay $250,000 for a home that was appraised at $200,000, the bank would consider $200,000 as the lending value.

Now that you have qualified for your mortgage to purchase your new home you need to decide on the options available to customize the mortgage to your future needs.  We’ll talk about those next time.

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Comments

Posted by: Eagleone on January 10 2008 8:20 AM

Haha... thats the carrot...

("if the value of your home was to appreciate at only 5% per year your home would be worth approximately")...

hmm kind of like a margin call if it goes the other way though depending on the direction of the market... eeek ($91,225.70) in the hole in only five years. The US housing market reality today. Banksters in action lol.