This is a guide designed to help you assess your credit rating score and understand what you can expect to receive from a lender, in the form of interest rates and fees. Please keep in mind this is only a general guide and some lenders use their own method of evaluation and credit score grading. Your actual FICO credit score is only one component of the "grade" that a lender assigns to you. The components that make up your grade are: types of credit history, debt ratio, LTV ratio and credit score number.
Types of Credit History
Credit can generally be broken down into three categories: mortgage credit, consumer credit and public records.
Mortgage credit. Your specific payment history on existing and previous mortgages. The past history of payments made on a mortgage loan can be a good indicator of a borrowers attitude toward mortgage obligations. Payment history on mortgage debt is very important when lenders are determining your credit grade. If you've never owned a home before, this type of credit will not be applicable to you.
Consumer credit. This category covers revolving credit and installment loans. Examples of installment loans are longer term credit with structured payment plans, like auto loans and student loans. Revolving credit examples are lines of credit, financial institution credit cards and home center credit cards.
Public records. The third category covers public records related to your credit, such as bankruptcies, collections and foreclosures. A borrower with an "A" grade would not have any bankruptcy within the past 2 to 10 years. Meanwhile, a "D" grade borrower could currently be in bankruptcy.
As a general rule, the more serious the borrower's credit problems, the lower the credit score, and the lower the grade the lender will assign to the borrower. As the grade decreases, the borrowers cost will increase (in the form of higher rates and fees) because the borrower is seen as higher risk to the lender.
Upon applying for a mortgage, a lender will review the capacity of the borrower to repay the mortgage loan. Lenders calculate the debt ratio by summing up all of the borrowers monthly debt service payments and divide it by the total monthly income. You can read more about this calculation in our other article, here. If a borrower has a low debt ratio, the grade assigned by the lender will be higher. Alternatively, if the debt ratio is high, the grade score will be low.
Loan-to-value (LTV) ratio is the mortgage loan amount divided by the appraised value (or purchase price, whatever is less) of the home. An easy example is, a loan amount of $200,000 on a purchase price of $400,000 equals an LTV of 50%. The higher the LTV ratio, the more risk the lender is exposed to and therefore the lower the grade they will assign to a borrower. There are restrictions on LTV ratios in most cases. For example, most refinancing situations are limited to a maximum loan amount of 80% LTV. There are other LTV restrictions when purchasing a home, ask your broker for details. In general, a better credit grade will equal a higher LTV ratio that you're able to secure for your mortgage loan.
FICO Credit Score
The most common credit indicator is known as your FICO score. The higher the number, the lower the credit risk you present to a lender.
FICO stands for Fair Isaac Company, which is the company that created the original scoring system. Each credit reporting bureau has its own unique system that allows them to offer a score based solely on the content of their individual bureau's data. Even though there are different credit reporting bureaus, the numerical score you get from one bureau is based on the same scale as every other bureau. So although the data available at each bureau may be slightly different, they all report the scores on the same scale. The scores range from 375 to 900 points, and in general, a score of 650 or above indicates a good credit history. Average FICO scores fall into the range between 620 and 650. It should be noted that not all lenders give the same value to a particular credit score number.
Now that you know the factors that make up the "grade" assigned to you by a lender, you can estimate what to receive in the form of interest rates and fees. The highest possible grade (good scores/results for every factor) will receive the best interest rate. As your grade decreases, the interest rate you'll receive increases, along with the potential for fees you'll need to pay in order to close the mortgage loan.
If you feel like your grade might not be the best, there may be other compensating factors that help your overall application package, like a history of savings, long-term job stability, history of making monthly payments that meet or exceed the proposed mortgage payments, a large down payment or a large pay out received after the close of a settlement.
Shopping for a mortgage can be an overwhelming experience. Especially if you're a first time home buyer and you have little to no knowledge about the mortgage loan process. If you've started shopping online, then you've probably already found hundreds of mortgage sites quoting low ball rates for every length of loan term under the sun. One would think that if you just spend a few hours online you'll find the lowest rate available and receive the best deal. This is rarely the case. Don't play the interest game without all of the accompanying information!
Not All Low Rates Are Considered Equal
The cost of a mortgage loan is much more than just the interest rate. Many lenders will set the interest rate as low as possible and then hike up the fees attached to the loan once you've applied. To ensure the best deal, compare all of the fees involved with the mortgage loan along with the interest rate. Examples of fees are: administrative, flood certification, inspection, survey, underwriting, document preparation, tax service, courier service, processing and lender fees. If you compare companies using this approach, you'll find that a lot of the low rate lenders are not the best deal in town.
What?! I don't qualify for that rate?
The most important thing to learn about mortgages is that rates are based on your individual needs and financial situation. The rates quoted over the phone and/or online are not always accurate representations of what you'll qualify to receive. Most rates quoted are applicable only for individuals with perfect credit, a low debt to income ratio and either a large down payment or a lot of equity in their house.
Here are several qualifying factors that are important to be aware of before shopping for a loan:
Your credit history is important to lenders when evaluating your loan. An individual with many late payments will not be deemed as trustworthy for payment terms as someone with perfect credit. Find out what has been documented on your credit report and correct any mistakes as soon as possible.
2. Debt to Income
Lenders use your debt to income ratio to verify that you have the means to pay a monthly mortgage. To learn how to calculate the two main ratios used in the approval process, check out a previous article on the subject by us here.
3. Down Payment
There are several loans available with little to no down payment required, however, most of these loans come with a higher interest rate. Evaluate your finances and estimate the maximum amount of money you can afford to put down on your new home. Once you have made this estimate, find out how much house you can afford by using one of the many mortgage calculators you can find online.
If you are looking to refinance, receive a home equity line of credit, consolidate debts or make home improvements, then you need to know how much equity you have in your house before you apply. Most of the time, the more equity you have, the more money you can borrow. To estimate this calculation, the formulas below can help:
Equity Ratio = 100% - (Loan amount ÷ Value of the home)
Equity Dollar Amount = (Current value of the home) - (Loan balance)
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The mortgage approval process is not quick and easy. You will be required to submit detailed information about your personal financial history and these records will be scrutinized by lenders. Oftentimes, people have trouble locating the necessary documentation in the first place and that delays the overall process. If you're looking to purchase a home, it's a good idea to start gathering the necessary personal financial documentation as soon as possible. Then, when you meet with your mortgage broker or bank representative, you have the information ready to go.
In order to assist with your documentation gathering, here is a general list of what you'll need:
While you may not need to provide all of the documentation outlined here, the more you have the better. Worst case you won't need it, and best case you have it ready as soon as it's needed in the process. We hope this information helps you!
Although the exact amount and types of closing costs will vary with every mortgage loan, there are a few guidelines you can use to estimate your closing costs. We'll go through them in this article.
1. Lender Fees
Fees will vary from lender to lender. Your mortgage broker's job is to help you choose the lender with the best combination of rate and fees, from their pool of available lenders. These fees can range from $0 to $1000, depending on the lender and the applicant. Examples of these fees are underwriting fees and processing fees.
2. Third Party Fees
These are fees paid to various third party services, independent of your mortgage broker and lender. Often times these fees are negotiable and your mortgage broker may be able to assist with getting you the best price. Examples of these fees are appraisals, credit reports and inspections.
3. Title and Attorney Fees
Title searches are mandatory and the fees vary from province to province. The exact title related fee will be determined by the closing attorney you use. Attorney fees make up the remaining bulk of your closing costs. Hiring an attorney is required to close your mortgage loan and if you don't have one, your mortgage broker can recommend one. Along with performing the title search, an attorney will provide you independent legal advice on the terms of your mortgage deal. Most have predetermined prices for closing on a mortgage, and their fees also cover the transferring of funds between all parties involved in the deal.
4. Government Fees
Last, but not least, are fees set by government authorities in your particular province and municipality. Examples could be registration fees, land transfer taxes, city taxes, and other taxes applicable in your local area.
Overall, it's a good idea to set aside approximately $5,000 to cover closing costs when you are buying a home.
There are many factors involved when an underwriter reviews your application for a mortgage loan. This article will shine some light on how you can calculate two qualifying ratios on your own before you even start the mortgage application process.
First, let's look at the key pieces of data you'll need to calculate these ratios:
Monthly Housing Expenses
Your monthly housing expenses primarily consist of the monthly principal and interest payments identified in your mortgage agreement. In addition, housing expenses include property taxes and home insurance. For some people, condo/management fees would also be applicable. The sum of all these figures is your monthly housing expenses.
Monthly Personal Debt Obligations
Your monthly personal debt obligations include all of the payments you make to service your personal debt, from all credit sources. Examples could be credit card payments, student loans, car payments and payments on lines of credit. For revolving charge accounts where the balance stays the same every month, 5% of the balance is typically used to calculate the monthly payment. The sum of all your monthly debt service payments is your total monthly personal debt obligation.
Your income can be derived some several sources. The most important thing to have is documentation from the income source, which is typically your last two years Notice of Assessments and recent pay stubs. Here is a brief list of typical income sources:
Now that you've calculated your monthly housing expenses, personal debt obligations and income, you can use this data to determine two important qualifying ratios that underwriters use when considering your mortgage loan application. These ratios are called GDS (Gross Debt Service) and TDS (Total Debt Service).
GDS is the sum of your monthly housing expenses and heating costs divided by your monthly income. For cases where condo fees are applicable in the housing expenses figure, you only consider 50% of those fees in this calculation. The resulting figure should be no higher than 0.32, or 32%.
TDS is the sum of your monthly housing expenses (still only 50% of condo fees, if applicable), heating costs and personal debt obligations divided by your monthly income. The resulting figure should be no higher than 0.4, or 40%.
If your answers are higher than the guidelines written here, then in order to be approved for a mortgage, chances are you'll have to save more money for a down payment or pay off some existing debt. However, every case is unique, and if you have a high credit score or some valuable assets, that may help you get approved. If you calculate your ratios before meeting your broker or bank representative, you'll have a much better idea of your personal financial situation and how likely you are to be approved for a mortgage. For those who aren't likely to be approved, these calculations will give you a better idea of the things you'll need to work on in order to own to a home!