A mortgage is nothing more than a large loan secured by real estate. If you keep this simple concept in mind, everything else will fall into place nicely. There are a few key definitions you should be familiar with:
The big unknown for most people is figuring out how much of a mortgage they "qualify" for. This is another easy concept. A good rule of thumb is that you will qualify for a mortgage of about three times your family's gross annual income, assuming you have steady employment, a good credit history and relatively little debt.
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If you are a number cruncher, you can be a little more precise by calculating the same ratios your bank will use to qualify you for a mortgage. There are two ratios the banks will use; the gross debt service ratio (GDSR) and the total debt service ratio (TDSR). (Big names but easy to understand.) The GDSR is your monthly mortgage payment plus 1/12th of the annual property taxes, plus $75 for monthly heating costs. This figure is divided by your gross monthly income. If the answer to this formula is less than 32 per cent, you qualify under this criterion. The TDSR is exactly the same as the GDSR except you add the cost of car leases, loans, lines of credit, and minimum payments on credit cards to the mortgage payment, property taxes and heat. Then you divide this number by your gross monthly income and as long as this number is less than 40 per cent, you qualify under this criterion.
Calculating your family's gross income is another important factor to look at. The banks are very picky about the type of income they will use to qualify you for a mortgage. If you are paid a salary or an hourly wage, based on a typical 37.5-hour (or more) work week, then you are fine. However, if you are paid commissions, bonuses, get substantial overtime, or receive tips then it gets a little more complicated. The banks will want you to demonstrate that you have received this sort of income on a consistent basis over the last two or three years. If you cannot do this then they will usually only use your base salary to qualify you for a mortgage.
If you are self-employed, you will need to provide the banks with your last two or three years of Notice of Assessments from the Canada Customs & Revenue Agency (formerly Revenue Canada). The banks will look at the average of your net taxable income over two or three years to qualify you for your mortgage. In my experience, this usually means that the majority of self-employed individuals will not "qualify" for the mortgage they were hoping for.
Your credit history plays a very important role in qualifying for a mortgage. If you have had collection agencies after you or are consistently late on all your credit card or loan payments, you will have a hard time qualifying for a mortgage. Even forgetting to pay the minimum payment on a department store credit card can come back and haunt you if you do this consistently. Remember that it is not just what your credit situation is like today that counts, it's what your credit history has been like over the last five or six years.
The next big issue is the size of your down payment. A good rule of thumb is that the bigger your down payment, the easier it is to qualify for a mortgage. If intend to put 5 per cent down, the banks are very strict on their lending criteria, but if you have 50 per cent down, they will be much more flexible with you. There are a couple of programs available where you can buy with no money down but they are expensive and are difficult to qualify for. The majority of people will need at least 5 or 10 per cent of the purchase price of their home available for a down payment.
The most important piece of the puzzle is the real estate that is being used as security for the mortgage. If the bank doesn't like the security, you won't get your mortgage. The banks like to lend on highly marketable properties. If you are buying a home in a subdivision, or in a large urban area, you will not have any problem convincing a bank to use your home as security. However, if you are buying a farm in the middle of nowhere, the banks will be more hesitant to use this home as security because it is not as marketable as a home in an urban area. This usually means that they will either not give you the mortgage or if they agree to give you a mortgage it will be for a smaller amount than you were hoping for.
If you are thinking of buying a home, the first thing you should do is get a pre-approved mortgage from your local bank or mortgage broker. This will allow you to confirm if you will get the mortgage you are looking for and it will allow you to discuss all the other details of a mortgage. This is a great time to ask questions! Another option is to join the Mortgages In Canada Discussion Group, where you can pose your questions to hundreds of other Canadians. The group has several industry experts and lots of opinions on mortgage related topics in Canada. Just go to their web site to join the group.
So remember, qualifying for a mortgage is really just about having stable income, a good credit history and money for a down payment, and choosing a marketable property. Simple!
Andy MacDonald (BA Econ.) is president of MortgageBroker Inc. He has more than two decades of financial services experience and has long been an advocate for consumers within the mortgage industry. Visit his Web site at MortgagesInCanada.com.
