How Do Lenders Make Decisions?
Mortgage approval decisions are made in two steps. The first is a review of your credit report. The second is a calculation comparing debt and mortgage payments to your gross income. Let’s look in more detail.
Credit Report Review
This is a go – no go – decision step. If your credit meets the tests, lenders will go to step 2 to figure how much they can lend. If it doesn’t, you will be declined without further investigation. What do they look at?
Lenders will look at a credit report first for credit scores. With less than 20% down, you need a minimum credit score of 600 with CMHC. In practice, lenders require a minimum credit score of 620. Some require 650 to qualify for mortgage financing.
The credit scoring algorithm looks at much you are borrowing compared to card limits. Scores go down with balances above half the authorized limit. It will take into account any late payments and how recent those late payments were. It will look at whether you have repeatedly missed payments over time – showing a pattern of not making payments on time. All of these things factor in to the credit scoring model.
Lenders then look at the types of credit you have, for how long and at how you are using it. Ideally, you have at least two types of credit, that have been issued for at least two years, with a combined limit of at least $5000. That being said, a single credit card that you have had for several years with a $3500-$5000 limit is often good enough if your payment history is good.
If you have any collections, judgements or amounts owing under the Family Responsibility Office, you must show proof that hey are paid in full in order to qualify for a mortgage.
A previous bankruptcy will increase the minimum down payment you need and lenders will look to see you have had good credit history since the bankruptcy. If you have missed just one payment after bankruptcy, lenders won’t talk mortgages. If you declared bankruptcy twice, lenders will not provide mortgage approvals.
Finally, if you have dealt purely in cash because you thought that was the best approach for you – congratulations. Unfortunately, however, that will result in you having no credit score, no credit history and lenders won’t consider mortgage approvals unless you have a substantial down payment – ranging from 20%-40% down.
Comparing Debt Payments to Gross Income
This step is all about figuring out how much a lender will give you in a mortgage. It’s all math.
The first number is the total of debt, support and mortgage payments, property taxes and heat/utilities. The mortgage payment is based on your mortgage amount, amortization and either the actual mortgage rate or the stress test rate depending on your lender and down payment amount. Credit card and line of credit payments are calculated as 3% of the balances owing. Loan payments are determined on a monthly amount – same with property taxes. Most lenders use $100 a month for utilities. Insurance payments, cell phone payments etc don’t come into the discussion.
The sum of all those payments are divided by your eligible gross income – your eligible before tax income. So, for example, if you are salaried or have a base hourly rate with guaranteed number of hours, then that is your gross income. If you are self-employed, work through a union hall or are contracted, there are different rules. We need a minimum two tax years and we average line 150 from your Notices of Assessment (NOA) to arrive at the before tax income. If you work a lot of overtime, NOAs are also used to show consistency above your base income. It’s an average of the two years if you income is increasing – it is the lower of the two years if it is decreasing. If you don’t have two years as a self employed person, your income for this calculation is $0.
The lender then divides total payment by gross income – and it must not be greater than approximately 42%. This can vary based on your credit score. The lender will also compare just the mortgage, property tax and heat payment to gross income as well – and that has a maximum percentage.
Above is largely black and white. Lenders will also consider other factors. They become nervous if every last dollar is going into the down payment and legal fees – leaving you without savings in case of emergencies or life hiccups. They become nervous if you never spend more than 6 months in a job and continue to hop around, even if you are climbing your career ladder by doing so.
The house you choose to purchase can also become an issue with some lenders. Some won’t finance an older home with a stone foundation. Few will finance a house with a pier foundation. The house must have a permanent heat source.
So, while you have many decisions to make when selecting a lender and mortgage combination – lenders have a very detailed set of policies and procedures to follow when responding to a mortgage application.
This gives you just a glimpse behind the mortgage decision curtain to see what underwriters are doing with your application. It gives you guidance on how to position yourself and your credit report when thinking about property purchases.