Buying a home involves two main shopping expeditions: one for the right home and one for the right financing. It’s important to know how much you can afford to spend on homeownership.
Most prospective Canadian homeowners talk to a few lending institutions, such as banks, trust companies, or credit unions, or work through a mortgage broker, to get pre-approval for a mortgage before hunting for the actual home.
Getting pre-approval doesn’t guarantee that you’ll be approved for a mortgage loan, but it gives you a good idea of what you can afford. Also, the realtors you work with will often want to know whether you’ve been pre-approved.
Before pre-approving you for a mortgage, your lender will want to know whether you can handle the additional cost of home ownership. So, you’ll first need to understand what your budget is: What is your current monthly income? What are your regular household expenses (bills, groceries, services, etc.)? How much debt are you carrying (student loans, credit cards, car loans), and what are the monthly payments on it?
Your lender will also want to know how well you have paid your debts and bills in the past; a solid credit history will help you secure a mortgage.
So you will need a credit report, which you can obtain from a credit-reporting agency (Equifax Canada Inc. and TransUnion of Canada are the two main ones in Canada).
Once you have a good understanding of your finances, you can start looking at the price range for a home that will leave enough room in your budget for all your other expenses.
Two simple rules can help you figure out how much you can realistically pay for a home. The first is that your monthly housing costs — including monthly mortgage payments, property taxes and heating expenses — shouldn’t amount to more than 32 per cent of your monthly income. Lenders use these figures to determine pre-approval, so it’s good to take a look at them first.
The second rule is to look at your total debt load — including your existing debt and that of the house — and ensure that servicing it will not take more than 40 per cent of your monthly income.
If either of these percentages come out too high, you may have difficulty securing a mortgage. You can improve your situation by paying down some of your existing debts, trimming your household spending, or looking for a more modest home.
To pre-approve you for a mortgage, your lender needs you to document many of the details about your finances: your sources of income, financial assets, and debts. For example, you can document your income with a letter from your employer that confirms your salary.
Your lender will then determine the amount of mortgage that you can afford, and present you with a mortgage loan for a certain amount at a specified interest rate.
There are usually options available to fit your needs including different amortization periods or payment schedules.
Once you have agreed on the terms, the lender provides you with a written confirmation, or certificate, for a fixed interest rate.