The Learning Centre:
Home-Buying 101: The 4 essential pieces of pre-mortgage homework
You advise your students of the importance of doing homework so they can be better prepared for any tests that you (and life) will spring on them. That’s very good advice.
If you’re in the market for a mortgage, you’ll want to follow that same, smart advice—particularly if you’re a first-time home buyer. That’s because not doing your homework beforehand could potentially unveil a few roadblocks, which could prevent you from getting a mortgage.
Here are four pieces of homework to help improve your chances at landing that mortgage:
HOMEWORK ITEM #1: REVIEW YOUR CREDIT REPORT/CREDIT SCORE.
Shopping around for a mortgage before reviewing your credit report or checking your credit score is like putting the cart before the horse… the chicken before the egg… the A+ before the… well… you get the picture.
Why reviewing your credit report is so important:
- It provides an overview of your entire financial history.
- Potential lenders use your credit report and credit score to determine the likelihood of your paying off debt, as well as how much interest they will charge you.
- Knowing your credit score beforehand gives you an idea whether you’ll be approved for a loan, and the chance to improve it before applying.
How can you get a copy of your credit report?
What if you spot errors on your credit report?
Immediately contact the credit-reporting agency from which you obtained your report. (Check your report at least three months before you start shopping around for a mortgage—as it could take some time to resolve any errors.)
What’s a credit score?
While a credit report serves as a (more detailed) report card on your overall financial history, your credit score is more your final grade—except instead of an A+ or B-, your credit score consists of three digits between 300 and 900.
Here is the scoring system so you see how YOUR score rates:
300 – 559
560 – 659
660 – 724
725 – 759
Why is your credit score so important?
Prospective lenders will use your three-digit credit score to determine your likeliness to pay off future debt (such as the mortgage you’re applying for). If you don’t have a good credit score, the lender may refuse to approve your mortgage, or decide to approve it for a lower amount, and/or a higher interest rate.
Knowing your credit score beforehand will give you a realistic expectation on whether your score is high enough for a lender to approve you for a mortgage loan. If your score is on the lower end of the spectrum, you can then focus some time on building up your credit rating before going through the mortgage application process.
Did you know we offer a ‘Credit Score 101’ Lunch and Learn, exclusively for education members? Have one of our financial specialists contact you for more details and to book.
HOMEWORK ITEM #2: GET A PRE-APPROVED MORTGAGE.
‘Love at first sight’ may end up in heartbreak if you rush into house hunting before finding out if you can actually afford the abode you have your heart (and sights) set on. The pre-approval process will determine the maximum amount a potential lender will qualify you to borrow.
The benefits of getting a pre-approved mortgage include:
- Getting a more realistic expectation of which homes you can afford
- Locking in an interest rate in case interest rates rise before you make a purchase
- Being able to estimate your mortgage payment so you can budget your cash flow accordingly
- Having the power to make an immediate offer—which could make all the difference between winning and losing out on the home you’re interest in
What kind of information/documents should you bring to a pre-approval interview?
- Identification (usually two pieces of government-issued identification with your photo)
- Current pay stub/proof of employment
- Letter from your school board (to help substantiate your employment/income)
- Recent financial statements (to show you can cover down payment and closing costs)
- List of assets (vehicles, investments, etc.)
- List of liabilities (credit card balances, car/student loans, lines of credit, etc.)
What questions should you ask during a pre-approval interview?
- “If interest rates go down after I am pre-approved, do I automatically get the lower rate?”
- “How long is the pre-approved interest rate guaranteed?”
- “Can the pre-approval be extended?”
What are some other things to keep in mind about a pre-approval?
- A pre-approval does not guarantee that you will get the mortgage loan.
- Once you have a specific home in mind, the lender will want to verify that the home or property meets certain standards (such as the condition or market value of the home) before approving your loan.
- If certain standards aren’t met, the lender could decide to refuse your mortgage application, even though you had received a pre-approval for a certain amount.
HOMEWORK ITEM #3: LEARN YOUR ‘GDS’ FROM YOUR ‘TDS’.
Just as your students throw around acronyms such as ‘LOL’ (Laugh Out Loud) and ‘TMI’ (Too Much Information), mortgage lenders tend to use abbreviations for two specific financial formulas used to determine how much money they can lend you: ‘GDS’ and TDS’.
GDS = Gross Debt Service ratio: This is the percentage of your gross income before deductions (such as income tax) that would be required to cover home-related costs such as mortgage payments, property taxes, heating, and condo fees. As a general rule of thumb, the GDS ratio should not be more than 32% of your gross income.
TDS = Total Debt Service ratio: This is the percentage of gross income required to cover home-related costs including mortgage payments, property taxes, heating, and condo fees, if applicable—plus all of your other debts, such as credit card payments, car/student loans, lines of credit, child or spousal support payments, etc. Generally the TDS ratio should not be more than 40% of your gross income.
HOMEWORK ITEM #4: EDUCATE YOURSELF ON YOUR MORTGAGE OPTIONS.
Fixed or variable rate? Open or closed?
Having mortgage options is a good thing. But if you don’t know what your options are or what differences exist between them—you could definitely end up with the wrong mortgage.
First, know about your interest rate options.
- Fixed interest rate: With this option, the interest rate remains set for the entire term—as does the amount of your regular mortgage payments—which means you’ll know in advance how much of the original loan amount will be paid off during the term
- Variable interest rate: With this option, the interest rate can increase or decrease during the term according to changes in market/Bank of Canada interest rates
Next, learn more about the types of mortgages.
The main difference between these types of mortgages is the amount of flexibility you have in making extra payments (also known as ‘prepayments’) on the principal, or in paying off the mortgage completely.
- Open mortgage: With this option, you can make prepayments at any time during the term, or even pay the mortgage off completely before the end of the term, without having to pay a prepayment penalty.
- Closed mortgage: With this option, the interest rate is usually lower than that of an open mortgage. However, if you want to change your mortgage agreement during the term (i.e. make more than the maximum prepayments allowed per year to take advantage of lower interest rates), you will usually have to pay a penalty charge to break your mortgage agreement.
At the end of the day, the most important lesson when it comes to applying for a mortgage is: the more homework you do, the better off you’ll be.
Need help with your mortgage homework? Reach out to us. We can answer your questions and even customize a mortgage with your specific needs in mind.
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The information provided is general in nature and is provided with the understanding that it may not be relied upon as, nor considered to be, the rendering of tax, legal, accounting or professional advice. Please ensure to consult your accountant and/or legal advisor for specific advice related to your circumstances. Educators Financial Group will not be held responsible or liable for any losses, costs, damages or expenses incurred by reason of reliance as a result of the aforementioned information. The information presented was obtained from sources that are believed to be reliable. However, Educators Financial Group cannot guarantee their completeness or accuracy.