Aside from considering the different options when purchasing a home, you as a home buyer need to understand how lenders look at your “financial situation ” when deciding whether to grant mortgage financing.
By understanding what lenders look for, you will be better prepared to work with your mortgage consultant and make the whole process as smooth and efficient as possible.
There are two main areas to examine:
• Understanding credit. What factors about applicants do financial institutions consider? Lenders look at the 5 C’s of Credit: Capacity, Capital, Collateral, Character and Credit.
• What type of borrower are you? Common borrower profiles are risk averse, risk tolerant, and those with flexible borrowing requirements. In this section, we offer some guidance to help you determine what type of borrower you are. We look at some key questions for prospective borrowers to ask themselves.
1. Understanding Credit
Remember, lenders run a business to make money, not lose it. Those with good/better credit receive lower rates, and those with spotty credit receive slightly higher rates — the higher the risk, the higher the return for the financial institution. As part of the application process, lenders examine prospective borrowers according to varying requirements, however central to all decisions are the 5 C’s of credit: Capacity, Capital, Collateral, Character and Credit.
Capacity to repay the loan is the most critical of the 5 C’s. Is your income sufficient to support the repayment of the requested loan amount? This is where lenders look at your Gross and Total Debt Service Ratios. Do the monthly carrying costs of the loan represent less than or equal to 32% of your total monthly income? Including other loans outstanding, do your loan obligations and carrying costs represent less than or equal to 40% of your total monthly income? Prospective lenders will also want to know about any other sources of income you may have to repay the loan, in case your steady income stream is interrupted.
Capital is the money you have personally invested in the purchase, otherwise known as your down payment. The amount of your own money put into the home portrays a message of confidence and trust. The more money you contribute, the less risk for the lender of losing money if default occurs, and the more likely it is that you will do all you can to maintain your payment obligations. Capital also reflects your ability and willingness to save money and accumulate assets, confirming that you can manage your financial affairs adequately within your income. The higher your net worth, the more you have as a cushion for repayment in the event you run into a financial setback. Lenders will look at the source of the down payment to confirm that it comes mostly from the applicant’s own resources such as savings, RRSPs, a family gift or unencumbered assets. A lack of accumulated worth could be a danger signal to lenders in some circumstances.
Collateral is additional security you can provide the lender should you for some reason not be able to provide repayment. In real estate transactions, collateral is generally the property, and the lender will want to ensure that the property for which they are providing mortgage financing is marketable real estate. An appraisal will determine whether the subject property has sufficient value to support the requested mortgage amount, taking into consideration any deficiencies that may affect the ability to resell. Collateral may also include such things as investments, other real estate, stocks, etc.
Character is your reputation and reliability — the general impression you make on the potential lender. Are you trustworthy enough to repay the loan? Factors associated with your character can include your educational background, business experience, length of time at your current employment and current residence. Credit Credit is the evaluation of your habits in meeting credit obligations. Information about your credit history is stored at the credit agency, or “credit bureau,” and indicates how well you have paid your bills over the last six years. All major credit cards, auto loans, leases, etc. are reported to the credit bureau. A lender will evaluate your ability to maintain your obligations and try and determine how well you live within your means. Some individuals make the mistake of not paying the minimum monthly obligations on loans and credit cards with the expectation of making a larger payment the following month. These missed payments appear on their credit report, branding them as chronic “late-payers” for the next six years. If there are any problems with your credit bureau, you will need to provide a full and satisfactory explanation to the lender.
2. What Type of Borrower Are You?
Your mortgage consultant will guide you through the myriad of options that are available and get you the mortgage product that best suits your individual needs. In order to get the ball rolling, it is helpful to begin thinking about what mortgage product options you would feel comfortable with. By having an understanding of who you are, the mortgage process becomes more efficient and your satisfaction over the term of your mortgage increases.
Is some fluctuation and change in payments acceptable?
Do I want the comfort of knowing what my payment is every month and of knowing it will not change for the whole term?
Do I want the lowest payment possible?
Do I want to pay down my mortgage as soon as possible?
How much down payment am I comfortable with, while not putting myself and my family into financial difficulty?
Are there any credit issues about which I will need to provide documentation? There are numerous other considerations that your mortgage consultant will cover with you, however this will be on a case by case basis and will depend on your own personal situation.
Other issues that may need to be addressed & require special consideration are:
• Nature of income — self-employed, commission based, or salary, for example
• Status of applicant — new immigrant, foreign investor, etc.