Before you start looking for a mortgage, assess your financial situation. There are steps you can take to make sure you are financially prepared to buy a home.
Examine your credit report
A potential lender will review your file before approving your mortgage application. Before you start looking for a mortgage, order a copy of your credit report. Make sure your file does not contain any errors.
If you don’t have a good credit rating, the mortgage lender can:
- refuse to approve your mortgage
- approve your mortgage for a lower amount or at a higher interest rate
- only review your application if you have a large down payment
- require another person to co-sign the mortgage
- require mortgage loan insurance even if you have a down payment of 20% or more
Educate yourself on how to order your credit report.
Respect your budget
You need to prove to your lender that you can afford to pay back the amount requested. This is an eligibility criterion.
Lenders and mortgage brokers use your financial information to calculate your monthly housing costs. They also calculate the total amount of your debts. They use this information to determine what you can afford.
Lenders and brokers consider the following information:
- your income (before taxes)
- your expenses (including utilities and living costs)
- the amount borrowed
- your debts
- your credit report and rating
- the amortization period
Total monthly housing costs
Total monthly housing costs should not exceed 35% of your gross household income. This percentage is also called the gross debt service ratio (ABD). You may be eligible for a mortgage even if your ABD ratio is slightly higher. However, you increase the risk of accumulating more debt than you can afford.
The monthly accommodation costs include:
- mortgage payments
- property tax
- heating costs
- 50% of condo fees (if you have a condo)
Total amount of debt
The total amount of your debts should not exceed 42% of your gross income. This amount includes the total monthly housing costs and all your other debts. This percentage is also called the Total Debt Amortization Ratio (ATD).
You may be eligible for a mortgage even if your ATD ratio is slightly higher. However, you increase the risk of accumulating more debt than you can afford.
Other debts may include monthly payments for:
- credit card balances
- auto loans
- lines of credit
- student loans
- child or spousal support
- any other debt
How the stress test affects your eligibility
Federally regulated entities, like banks, require that you pass a stress test to get a mortgage. This means that you must prove that you can afford to repay the payments at a qualifying interest rate. This rate is generally higher than the actual rate indicated in your mortgage contract.
Some credit unions and other lenders are not federally regulated. They may also ask you to take the mortgage stress test.
Your lender determines the allowable rate that it uses for the stress test. This rate depends on whether or not you need to obtain mortgage loan insurance.
If you need mortgage loan insurance, the lender will use the higher interest rate of the following:
If you don’t need mortgage loan insurance, the bank will use the higher interest rate of the following:
For example, suppose you are applying for a mortgage from a bank. You have a down payment of 5% of the value of the house.
Suppose that :
- the interest rate negotiated with the lender is 3.5%
- the posted interest rate of the Bank of Canada’s 5-year conventional mortgages is 5.14%
You must take out mortgage loan insurance since your down payment is less than 20%. In this example, you must qualify for the Bank of Canada’s posted rate of 5.14%.
Use the Mortgage Eligibility Assessment Tool to determine if you can get a mortgage.
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