A Guide to Mortgage Pre-Approval
As housing prices continue to rise and interest rates begin to rise alongside them, home purchase has become increasingly complex. So too, have mortgage decisions for potential home buyers. Can you afford the house you want? How much of a mortgage can you afford? And how much is your mortgage lender willing to lend you? Mortgage pre-approvals may provide the answers you are looking for. They can give an accurate appraisal of your qualifications and exactly how much house you can afford. They can also deliver you some peace of mind by guaranteeing rates for 90 to 120 days. Finally, pre-approvals can help you with negotiations. Realtors and sellers will know you are a serious buyer.
Table of Contents
What is a mortgage pre-approval?
Mortgage pre-approval is the process of pre-qualifying for a mortgage. With pre-approval, you’ll receive a document confirming that you qualify for a mortgage loan up to a specific principal limit. The pre-approval often includes additional specifics, including a term and interest rate. Lenders will guarantee that interest rate for a particular period, usually 90 to 120 days. You will also receive information about amortization rates and terms. Mortgage pre-approvals are not required to purchase a home, but they do provide peace of mind in knowing exactly how much house you can afford.
Why is it important to get a mortgage pre-approval?
Again, neither lenders nor buyers require mortgage approvals in Canada. However, they do offer some significant benefits. Of course, the most obvious is that they help you define your housing purchase budget. However, a mortgage approval also provides you with some leverage as a buyer. It removes a step, expediting the home buying process. You will go into negotiations knowing you have already secured a mortgage loan which could win you concessions from a buyer. Finally, shopping around for pre-approvals allow you the time to focus on getting the best mortgage loan package. You can compare rates, terms, and other details without the added pressure of an impending sale. And again, you will have a guaranteed rate for a specific period that can protect you, particularly from rising rates.
What factors affect mortgage pre-approval?
A mortgage pre-approval involves a thorough assessment of your financial situa-tion. This includes your income, savings, liabilities, assets, and credit score. Keep in mind that you can actually lower your credit rating if you request a credit report more than three times in six months. For this reason, you may wish to restrict your mortgage pre-approval requests to no more than three lenders.
Mortgage pre-approvals often start with your credit score. You will generally qualify for the best rates and terms if you have a relatively good credit score be-tween 680 and 900. You could still be eligible with a lower score, but typically it will not be with a major lender, and you may have a higher interest rate and less ideal terms.
Lenders will also consider the down payment you have available. This is the sum of money you will contribute to the purchase outside of the mortgage. The Ca-nadian government has precise rules about the amount of down payment you must make on any house you buy. The minimum down payment is between 5% and 20% of the home's purchase price. However, if you put down less than 20%, you will have to buy mortgage default insurance through an insurer such as the Canadian Mortgage and Housing Commission (CMHC).
There are additional federal rules regarding down payments that you should be aware of. For homes costing less than $500,000, you must put down 5% or more. For homes costing over $500,000 but less than $1 million, you must have a down payment equal to 5% of the first $500,000 and then 10% of any amount over the $500,000 threshold. If the house you purchase is over $1 million, you must have a minimum down payment of at least 20%.
Debt Service Ratio
Mortgage lenders also use debt service ratios to determine the amount of mort-gage you can qualify for. The gross debt service ratio is the percentage of your monthly household income that covers your housing costs. This number cannot exceed 39%. They also use the total debt service ratio, which considers your hous-ing costs and other debts, and it must not exceed 44%.
You will need to provide specific documentation that typically includes a mort-gage application and identification, pay stubs, and tax documents. Most institu-tions do not charge a fee to provide you with a mortgage pre-approval. You are also under no obligation to commit to taking a loan with the lender who pre-approved your mortgage loan. Some of the additional documentation you may be asked to provide include:
- Official government identification
- Proof of income – This could include pay stubs and letters from your em-ployer and a statement regarding the length of time you have been em-ployed with this employer. However, if you are self-employed, you will like-ly be asked for a notice of assessment from the Canadian Revenue Agen-cy.
- Proof of down payment and ability to pay closing costs, including recent financial statements from your bank accounts and investments)
- Proof of any other assets you own, such as a car, cottage or boat.
- Information about other debts. This can include credit cards, lines of credit, spousal or child support payments, student, car or personal loans
Once the lender has received all of your documentation, they will assess it and provide you with a letter stating exactly how much of a mortgage loan they are willing to provide to you. This, in turn, can inform how much of a house you can buy.
Where to Get Mortgage Pre-Approval
Mortgage pre-approvals are available from various lenders, including banks, caisses populaires, credit unions, mortgage companies, insurance and trust com-panies. You can also get them from mortgage brokers and websites. Here are some of the most common:
Mortgage brokers are not lenders but work on behalf of mortgage lenders as an intermediary between lenders and borrowers. They are licensed and monitored by federal and provincial bodies. Certain types of lenders only work through mortgage brokers. The brokers themselves tend to work with several mortgage lenders and will compare available offerings on your behalf to get you the best deal on your mortgage.
Make sure you ask which lenders your broker works with, as they may not have access to all lenders. You may also want to request pre-approvals from several brokers to ensure you have access to as many products as possible. They do not usually charge a fee for their services and instead receive a commission from the lenders they work with. This, too, is something to keep in mind when choosing a broker.
Comparison sites are a great tool you can use to do an initial assessment of lenders to get a sense of the variety of mortgage financing available to you and see who you may want to start a formal pre-approval with. Comparison sites can only give you a good idea of your financing options. They cannot provide you with an actual pre-approval.
Lenders include banks, caisses populaires, credit unions, mortgage companies, insurance and trust companies. It’s a good idea to get financing offers from sev-eral lenders as they often offer different terms, conditions and even interest rates for similar mortgage financing products.
Benefits and Limitation of a Mortgage Pre-Approval
Pre-approvals deliver several significant benefits for home buyers. The most obvious is that they give you piece of mind in knowing exactly how much house you can afford. They can also give you more confidence in the buying process, and they send a message to sellers and realtors that you are serious. Pre-approvals also bring the additional security of 90-to-120-day rate guarantees to protect you if interest rates rise. However, the pre-approval rate is not binding if rates drop. You can still access the lower rate.
There is no cost for a mortgage pre-approval, and they are non-binding, meaning you are not obligated to use the lender you received the pre-approval from. You can still shop around for better terms and rates at any time in the process.
As great as pre-approvals are, there are still limitations you should be aware of. First, understand that they are not an actual mortgage. For example, most experts advise that you do not substitute a mortgage pre-approval for a financing clause in a purchase offer for a house. Some pre-approvals simply guarantee an interest rate, and you don’t qualify until you apply for an actual mortgage.
If you are pre-qualified by your lending institution, the pre-approval will not be valid if your financial circumstances change. For example, if you take out additional loans or credit cards, lose your job or certain other factors. Many lending institutions also want appraisals of the properties they are mortgaging. If the house you are buying is not worth the mortgage you were pre-approved for, you will not get that amount.
Finally, just because you have been pre-approved for a specific mortgage doesn’t mean you should buy a house at the top of that price range. This is just what the lender is willing to give you. Look for a home that fits your budget and your debt servicing ability.
These limitations do not render the pre-approval useless, but they do mean that you must still protect yourself.
How to Apply for Mortgage Pre-Approval
Mortgage pre-approvals are available from a wide variety of lenders and mortgage brokers. Call or make an appointment to begin. You can often start the process online with many lenders and some brokers by answering a few questions. However, at some point, you will have to provide documentation of your credit history, including assets, liabilities and earnings, and your current wages and existing loans and accounts. You will also likely speak directly to a representative of the institution at some point in the process.
How to apply for mortgage pre-approval online
If you start the mortgage pre-approval process online, be sure you are applying for an actual pre-approval rather than a pre-qualification. These are very different things. A pre-qualification gives you a rough estimate of the amount of house you can afford after answering several questions. It is a less formal process, and you will not have a document in hand that explicitly confirms your mortgage pre-qualification amount and rates. That said, it is not a bad idea to begin by seeing what you would pre-qualify for in terms of a mortgage.
Mortgage Stress Test
The government of Canada introduced the mortgage stress test in 2018, and it applies to all new mortgage applications, even if you make a down payment of 20% or more on your new home. In June 2021, the Office of the Superintendent of Financial Institutions (OSFIO) and the Department of Finance introduced new rules to the mortgage stress test that will impact home buyers.
These rules are meant to protect lenders from borrowing more than they can afford for a new house if interest rates rise. Essentially these rules use a benchmark rate, or an additional rate tacked on to the rate offered by your lender, and your existing financial circumstances must be able to support your payments at that rate. If interest rates rise when it comes time to renew your mortgage, you will still be able to make your payments.
As of June 2021, the minimum qualifying rate is based on either the benchmark rate of 5.25% or the rate offered by your lender plus 2% – whichever is higher. So, if your lender offers a rate of 3.10%, you will have to use the 5.25% qualifying rate in your stress test. If your lender provides a rate of 3.75%, you will have to qualify using a rate of 5.75%.
After Mortgage Pre-Approval
With a mortgage pre-approval in hand, you can begin shopping for a house. You will still have to go through the formal process of applying for a mortgage after pre-approval, but the pre-approval will expedite things. For example, the lender may request that you conduct a home inspection, or the house may need to be appraised.
However, the lender will already have your documentation and application in hand. Your rate is already locked in unless rates have dropped, so you have that done as well. The mortgage application following pre-approval is relatively straightforward and quick. However, do keep in mind that if your financial situation has changed, you may have to start the process again.
Mortgage Comparison Websites
Consider a pre-approval? Start with these mortgage comparison sites.
- ThinkHomeWise is a mortgage comparison site that deals with over thirty lenders and boasts that it can get you mortgage results within 5 minutes. You start with a brief questionnaire, and they do not pull your credit history, so it will not affect your rating. They do the negotiating for you and can arrange for a pre-approval. There is no fee for their service.
- Hardbacon is a similar site that compares mortgage offerings. You have to become a member in order to access all of its services. However, there is no fee to register. This site compares over 300 mortgage products and can save you thousands of dollars over the course of your mortgage.
- LowestRates compares offerings from 75 plus mortgage lenders. You start with an online quiz that takes around three minutes to complete. Like many other comparison websites, this site can save you money by helping you narrow your options and find the best initial rates and terms.
- Nesto is a mortgage shopping website that compares over 10+ mortgage lenders within seconds to find the best commission-free mortgage rates. You can also apply for a mortgage through their website.
The Bottom Line / Our Final Thoughts
Mortgage pre-approvals make good financial sense. They will help you take a more logical approach to your house hunting by helping you avoid looking at properties that are out of your reach financially or, conversely, ignoring a home that you were not aware you could afford. Obtaining a pre-approval allows you the luxury of comparison shopping for mortgages before you are under pressure during the buying process. However, it is essential to remember that despite all the advantages offered by a pre-approval, you should still protect yourself with a financing clause in your offer.
Frequently Asked Questions
Yes, mortgage pre-approvals can affect your credit score if you obtain more than three pre-approvals. Because each approval requires the lender to pull your credit rating, it will look like you are suddenly applying for a lot of credit and subsequently reduce your score. However, credit rating agencies recognize that the pre-approval process means you may apply to more than one, so more than three appears to be the number that triggers a rat-ing issue. You can get around this by starting with a mortgage comparison tool and choos-ing the best three options it provides to request formal pre-approvals from.
The length of time a mortgage pre-approval is valid differs depending on the lender and the borrower's specific circumstances. Most are valid for 90 to 120 days. There are very few that are valid beyond 120 days. If the rates lower during the period of your mortgage pre-approval, you will still be eligible for a lower rate. However, keep in mind that these rates can be affected if your credit score or financial circumstances change. Always protect yourself with a financing clause.
Mortgage pre-qualification and mortgage pre-approval are very different financial as-sessments. Most mortgage pre-qualifications rely on your estimates of your finances ra-ther than the hard documentation and credit scores required by a mortgage pre-approval. Think of a pre-qualification as a first step in the process. It will give you a good idea of how much house you can afford, your monthly mortgage payments and how much you will need to provide for your down payment and taxes. However, it does not guarantee rates or terms in the same way that a pre-approval does.