Steps to take before taking a mortgage
It’s the new year, and if one of your new year goals is to be a homeowner, we have got you covered. Buying a home is a major milestone for many and it can be an overwhelming process. Plan ahead with the following steps to make the home buying process as smooth as possible:
Before you start any project, the first step should always be research. Start by looking into average home prices in the area that you want to buy and mortgage rates. Next make yourself familiar with what factors affect your mortgage like down payment, credit score and debt to income ratio; and hidden costs related to homebuying.
Keep up to date with mortgage rules which determine your eligibility for a mortgage, and also government incentives available for homebuyers. Some of the government incentives are –
First-Time Home Buyer Incentive – For eligible first-time homebuyers, the government puts in either 5% or 10% of the home value, depending upon the type of home. This amount is interest free, and you have 25 years to pay it back. It is a shared equity with the government, and so if you sell the property, the amount that you pay back will depend on the price that you sold for.
Home Buyers’ Plan – If you are a first-time home buyer, you may be able to withdraw up to $35,000 from your RRSP to use for a down payment.
2. Save for down payment
Down payment is what you put in towards the price of the house, and the mortgage covers the rest of the amount. In Canada, the minimum down payment is 5% for house prices less than $500,000; and 20% for houses costing more than a million. If your down payment is less than 20%, you need to buy mortgage loan insurance which can be an additional cost.
You should aim to have as much down payment as possible. Your down payment is one of the factors that will determine the maximum mortgage that you are eligible for. A large down payment can also save you on interest charges since you won’t have to take on a high mortgage.
You can use monetary gifts for down payment but you will need documentation that it is actually a gift and not a loan.
3. Use a mortgage calculator
Almost all major banks have some sort of a mortgage calculator. These calculators ask for inputs like annual income, down payment, monthly expenses (excluding housing expenses like rent), loan payments etc. Using these numbers, you get an estimate of your mortgage amount. This gives a fair idea of what you may be able to afford and can help you build up a budget.
It is important while using these calculators to be honest. For example, do not overestimate your income and underestimate your expenses to get a higher mortgage amount. Remember that a mortgage is a long-term liability, and you want to make sure that you are able to afford it. But feel free to play around with the numbers to see how the different factors affect your mortgage.
4. Improve your Credit
Before you go to a mortgage provider, check your credit reports from both credit bureaus, TransUnion and Equifax. A good credit score and report is important for a mortgage and will also determine the interest rate that you are offered. Learn more about what to look for in a credit report here. You can also download our free Credit e-book to learn more on how to improve your credit score.
5. Pay off debts
Paying off your debts has a two-fold positive effect. It improves your credit and since you will have a lower debt to income ratio, you may be eligible for a higher mortgage amount.
6. Prepare documents
Some documents that you will need to prepare before going to a mortgage provider are: identity documents, employment information (pay slips, T4, employment letters), banking and investment statements showing you have the funds for the down payment and closing related costs, list of assets and liabilities etc.
7. Search for a mortgage provider or broker
You can get a mortgage directly from a mortgage lender like banks, or work with mortgage brokers. A mortgage broker doesn’t lend to you directly but instead searches for a mortgage lender for you. There are pros and cons to both. For instance, you may be more comfortable working with a bank with whom you already have a working relationship; but mortgage brokers can provide you different options and negotiate on your behalf. Make sure whichever route you take that they are appropriately licensed and trustworthy.
8. Get a pre-approval
Once you have the above steps ready, you can go to a mortgage provider or broker, and get a pre-approval. During a pre-approval, you get pre-approved for a mortgage amount and you can lock in an interest rate. Usually, the pre-approval is valid up to 3 months. Having a pre-approval is helpful since if interest rates go up during the period, you will still get the rate you were approved for. However, if rates go down, the mortgage provider may honor the lower rate. You can also use your pre-approved mortgage amount to narrow your search for a home.
If you do get denied a mortgage, make sure that you ask for the reasons and how you can rectify them, so that you are better prepared for the next time.
After you have a pre-approved amount, you can start house hunting and put in an offer on a home of your choice. However, make sure that your financial situation doesn’t change dramatically between the pre-approval and the final approval stage. For example, do not take on new debts or change jobs during this time as that may affect your final approval. If some unforeseen circumstances do occur which affect you financially, inform your mortgage provider. Your provider or broker may be able to offer you other options, or you may decide to postpone homebuying till you are on a sure footing.
Finjoy Capital is not a financial advisory firm.
This article is for informational purposes only and is not a substitute for individualized professional advice.