With today’s reality of stricter mortgage qualification rules, it has never been more important to plan ahead when buying a home. There are several missteps you can take that may seriously jeopardize your chances of approval for the amount you…
How do you really know when you’re ready to buy your first home? That’s definitely a common question. But, much like many of life’s milestones, you’ll likely never feel 100% ready. Thankfully, there are a number of key indicators we’ve outlined below that will help set your mind at ease.
- Lenders use several factors to determine whether to approve your mortgage application. Being aware of these details can help you better understand the process
- A budget offers a realistic and comprehensive picture of your current financial situation, and will help you identify areas where you may be able to cut back and save
- With mortgage rates hovering at historic lows and the economy taking a hit due to COVID-19, now is definitely a good time to think about buying your first home
Your debt-to-income ratio
Expressed as a percentage, your debt-to-income ratio (DTI) is a comparison of your monthly debt payments versus your monthly income. In other words, the amount you owe versus the amount you earn. Lenders use the ratio to determine how well you manage your monthly debt as well as your ability to repay a loan.
Monthly debt obligations include items such as credit card balances, rent, vehicle loans, insurance premiums and any personal loans. Examples of earnings include your income (and spouse’s income, if applicable), investment income, alimony or child support as well as government assistance programs.
Typically, a DTI of 36% or below is considered good; 37-42% is considered manageable; and 43% or higher will cause red flags that may significantly impact your chances of qualifying for a mortgage. An ideal debt-to-income ratio, therefore, is any percentage that falls below 36% to err on the side of caution. These figures may vary slightly based on one lender to the next. (See: What’s an Ideal Debt-to-Income Ratio for a Mortgage?)
What mortgage lenders consider
Lenders use several factors to determine whether to approve your mortgage application. Being aware of these details can help you better understand the process. These important considerations include:
- Credit score
- Income stability
- Debt obligations
- Down payment
To ensure you qualify for the best rate possible, you want to make yourself attractive to lenders. Make sure your credit score is high, you can prove your income, reduce your existing debt as much as possible and save even more than you may be required to put aside for a down payment. (See: Financing Basics for First-Time Homebuyers)
Important: While buying a home is extremely exciting, it’s imperative that you’re financially prepared for what homeownership entails. Be responsible with your financial situation – in the end it will pay off through successful homeownership.
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Housing market & economic outlook
The housing market and, consequently, mortgage rates, are influenced by many factors such as economic activity, supply and demand, and inflation.
With mortgage rates hovering at historic lows and the economy taking a hit due to COVID-19, now is definitely a good time to think about buying your first home. How quickly the market bounces back is reliant upon the length of time it takes to get Canadian businesses back up and running and for Canadians to be able to ease up on physical distancing measures.
The Organization for Economic Cooperation and Development (OECD) warned that the pandemic presents the biggest danger to the global economy since the financial crisis of 2008.
Over the last few years, the Bank of Canada (BoC) had been keeping rates steady, but believed that a substantial cut was necessary March 4th in order to bolster assurance among the public and business, when it announced that it was slashing its key interest rate target by half a percentage point to 1.25%. Then, on March 14th, the BoC once again cut the target rate by half a percentage point to 0.75%. And, finally, on March 27th, the central bank made a third 50 basis points reduction to 0.25%.
Just hours after the first cut, several banks matched the BoC, announcing 50 basis point cuts to their prime interest rates, which was great news for variable-rate mortgages. And with bonds continuing to fall, fixed mortgages were also reduced. Since the first cut, however, lenders have been doing damage control, reducing discounts on variable mortgages and raising fixed rates as they began pricing “risk premiums” into their rates.
Your lifestyle & budget
Establishing a budget is the first step to ensuring your lifestyle is kept in check and you can afford to be a homeowner. A budget offers a realistic and comprehensive picture of your current financial situation, and will help you identify areas where you may be able to cut back and save.
Your budget should include monthly income and expenses such as car payments, gas, cell phone, cable, utilities, groceries, restaurants, entertainment, public transit and any other area where you spend money. It should also take into consideration how much money you’ll be spending when you buy a home so that you can make cuts right away as opposed to trying to make changes when you’re already a homeowner.
Tip: Be disciplined with what goes in to and what comes out of your bank account. Even small measures can lead to great savings over time.
Be disciplined while managing your bank account. Curb your spending habits if necessary. Even small measures can lead to great savings over time. There are many simple ways to cut out excessive spending such as making meals at home instead of relying on restaurants or avoiding temptation to buy the latest tech gadgets. Clearly identify your needs versus your wants.
Tip: Set up a monthly automatic savings plan, which will transfer a specific amount of funds into a savings account. After a short period of time, you’ll hardly notice it missing.
You should also consider setting up a monthly automatic savings plan, which will transfer a specific amount of funds into a savings account, preferably one that pays some interest such as a TFSA. After a short period of time, you’ll hardly notice it missing.
Can you afford the down payment?
The more you can put down above and beyond the required amount – 5% of the purchase price for a home valued at $500,000 or less and 10% for the portion of the purchase price above $500,000 – the better. The smaller your mortgage and the lower amount of interest you’ll pay over your time as a mortgage holder, the quicker you can build home equity.
Example: If you’re buying a home valued at $500,000, your minimum down payment is $25,000.
If you’re having trouble coming up with the full down payment on your own, you may also be able to use a “gift” from a family member towards your down payment. This is not a loan, as it doesn’t have to be repaid. The person gifting you the money will be required to provide a letter, generally addressed to the mortgage company, which clearly outlines that the money is a gift and not a loan.
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