Before you peruse online house listings or start viewing homes with a Realtor, it’s crucial to know what you can afford. While simple calculations can be done to determine what price range you should be shopping in, most Realtors and loans officers will encourage you get pre-approved for a mortgage loan by a lender.
What is a pre-approval?
If you’ve saved for your down payment and you’re looking to buy in the next three to six months, it’s time to get pre-approved.
“You should get pre-approved even before you meet with a Realtor and before you start looking at homes, so you start setting realistic expectations upfront in terms of affordability and you don’t get caught up looking at houses that you love but can’t afford,” says Bernice Dunsby, senior manager of home equity financing with Royal Bank of Canada.
In addition, getting pre-approved will allow you to act quickly once you do find your perfect home and it may give you more confidence when placing an offer.
When you are pre-approved for a mortgage loan, you’re beginning the application process for the mortgage. To provide you with a pre-approval, a lender reviews your income, the source of your down payment, your assets and liabilities, and inspects your credit report to determine your credit worthiness.
According to BMO First Home Essentials, Royal Bank of Canada, you (and other applicants, if applicable) will need to provide information this information:
- Photo identification
- A record of employment such as a T-4 slip or a personal income tax return (if you are self-employed at least two years of personal income tax returns and financial statements)
- A letter from your employer stating length of employment and current salary
- The account numbers and locations of your bank accounts and investments
- Confirmation of your down payment (if it’s a gift, you need to provide a letter from the gift-giver stating the money does not need to be paid back)
- Details of assets, such as vehicles, investments, etc.
- Details of liabilities, such as credit card balances, car loans, student loans, or lines of credit, co-signed or guaranteed loans, or any other monthly obligation you may be paying on an ongoing basis at the time of application
- Name, address, telephone number of your solicitor/notary
After examining these criteria, the lender will determine the maximum amount you qualify for, and supply you a letter of pre-approval, which often guarantees an interest rate for 60 to 120 days. That letter is a commitment, subject to conditions, to loan you money.
It’s important to note that the amount is usually at the high end of what you could qualify for. It doesn’t necessarily mean you should search for a house that is listed at that exact price.
“Just because you’re pre-approved for a $600,000 mortgage, doesn’t mean you’re going to go out and try and find a $600,000 home,” says Dunsby. “You might be more comfortable, based on your spending habits and your current budget and anticipated increased expenses, looking at something in the $400,000-range.”
While being pre-approved doesn’t guarantee your mortgage application will be accepted on a specific property, it does speed up the process and may guarantee you a rate on a fixed mortgage for a specified time period. If rates fall, you’re still guaranteed the lowest rate available on a fixed mortgage during the guaranteed rate period.
However, guaranteed rates are not always provided with pre-approvals, since not all lenders provide a pre-approval product.
Not all created equal
While the pre-approval process is intended to give you peace of mind during your home search that when you find that home you will be able to pay for it, sometimes what you’re getting is a pre-qualification. It sounds similar, but it’s very different.
In a pre-qualification, a mortgage specialist will discuss what you may or may not be able to afford based on your current income and savings potential. In this instance, your financial information does not need to be verified and there is no credit application.
“We arrive at a ballpark figure, so you have an idea of what you could spend on a home,” says Dunsby, adding a pre-qualification can be done either face-to-face or over the phone.
“There’s so much that can go wrong with pre-qualifying,” says Marty Coubrough, president and owner of VERICO One-Link Mortgage & Financial in Winnipeg. “Even at the bank level, somebody looking to purchase a home will assume the bank is going to do their due diligence, and that they’re completely qualified, and the lender reps will give them the green light to go buy a house. The buyers don’t know there’s a problem until they put in an offer on the house, the offer’s accepted and the lender finds out a financing procedure wasn’t done until this far along in the process, and the buyers can’t get the house.”
“Pre-qualification is just a discussion,” says Paul Gazzola, a mortgage planner with Mortgage Architects in Guelph. “I’ve seen a lot of situations where the customer says they’ve been pre-approved at the bank but really they’ve been pre-qualified and when they go to do their credit bureau, there are all these debts they didn’t mention that now jeopardize their pre-approval limits,” he says, and adds he sees this scenario happen at least two or three times a month because some banks only offer pre-qualifications as opposed to pre-approvals.
Part of the problem is that some lenders, including banks, no longer do full pre-approvals, says Victoria-based Greg Stanley, CEO and president of Home n Work Mortgages. After some lenders found out they were “getting
shopped” as Stanley puts it, meaning buyers were getting pre-approved with them, but not following through with the loan, they decided it was no longer worth the time and expense to do it, he says.
“It’s a misuse of the word ‘pre-approval,’ by Realtors and brokers,” says Harold Kennedy, president and CEO of MorCan Financial in Toronto. “That’s what’s caused the buyer’s understanding of what they’re receiving to change.”
It seems ‘pre-approval’ has become a catch-all term for both pre-qualifications, based for the most part on unverified financial information, and true pre-approvals, which are based on verified financial information, where a credit check is done.
While pre-approvals are always subject to conditions, if you verify your financial information upfront, you’re that much closer to getting the loan, once the property you intend to purchase has been appraised by your lender and your credit history checked once more.
Some brokers, such as Stanley, shy away from getting a full pre-approval from a lender as some brokers will not want to flood busy lenders with pre-approval requests when they may not use one of the lender’s products.
“The lenders that have extremely low rates, they’re flooded with deals,” he says. “So the last thing they’re going to want to do is waste their time on something that may not come through.”
Stanley says that because pre-approvals are loaded with conditions, it shouldn’t matter if you have a pre-qualification or a pre-approval, as long as you keep the “conditional on financing” clause in your offer to purchase.
Dunsby says there is a place for both in the industry, depending on where you are in the home-buying process. If you’re thinking of buying in a year’s time, and you don’t have your down payment saved but just want to get a general idea of what you could afford based on your current income, than a pre-qualification may be an appropriate choice for you, he says.
“I would caution that in this type of marketplace, a pre-qualification really doesn’t stand for much,” says Dunsby. “The pre-approval is really where you’re taking that next step and starting the application process.”
To ensure you’re getting what you want, ask.
Provide documentation, request a full credit report, and see that the lender provides a certificate of pre-approval with a written commitment from the lender.
If you provide everything upfront, you should only need to worry about the value of the property, once you’ve put in an offer to purchase, says Coubrough.
Final approval process
If you’ve been pre-approved and your financial condition has not changed, the final approval process should be painless.
However, acquiring new debt since your pre-approval will jeopardize your ability to get the loan. Similarly, if at the time you applied you were employed and have since lost your job, your lender will have to re-do your application based on two people and determine whether or not you’ll still be granted a loan based on one source of income.
You’ll be asked to provide the offer to purchase and/or MLS listing with photo with the mortgage loan application to be submitted to your lender.
In all cases, the lender will have an appraiser conduct a home appraisal on the property you wish to purchase to ensure you didn’t overpay for the home. The property also has to meet Canada Mortgage and Housing Corporation (CMHC) or Genworth’s approval to have your mortgage insured should you have less than 20 per cent down payment.
Should you encounter that you find a home, put in an offer which is accepted and cannot secure financing, don’t fret – there are options.
If your monthly debt obligation increased because you acquired debt, and you had originally selected an amortization period of 25 years, extending the amortization period to 35 years might bring your monthly debt obligation down to an amount you can afford, says Dunsby.
If you were anticipating a 20 per cent down payment and now only have 10, instead of losing the loan, you may get mortgage insurance, which will increase your monthly payment but not prevent you from getting the loan.
“If you were turned down because of the home, that may help you negotiate with the seller to get the price lowered or get something repaired,” says Gazzola.
In addition, if you get your house appraised, and it turns out you paid more for it than it was worth, you can appeal what CMHC or Genworth comes back with as a value. At your expense, you can hire another appraiser and hope that he or she determines you paid a fair price for the home.
Whether you receive a firm pre-approval or an unverified pre-qualification, nothing is written in stone and pre-approvals are always subject to conditions. But Realtors and mortgage professions will agree, it’s important to know what you can or cannot afford before you put in an offer.
The pre-approval process includes a review of your credit worthiness. Here are some tips that will help you maintain a good credit rating:
- Make all loan payments and at least the minimum credit card payments on time
- Pay your utility bills on time and in full every month
- If you’ve never borrowed before, speak to your bank about applying for a credit card or an RRSP loan to help you build credit
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