Unless you are among the rare and independently wealthy, you’ll probably need a mortgage to buy a house.  It’s a fact of life for most of us.

If you’re a buyer just starting out, know that going through a mortgage pre-approval is crucial before putting in offers.  But where do you go? And what can you expect during the mortgage approval process?

The Mortgage Approval Process For Buyers

When shopping for your mortgage, the number of available options might come as a surprise.  The first option to come to mind is usually your bank. Sometimes, banks offer you the best deal.  However, we always recommend that you work with a mortgage broker who has access to other alternatives for you.  A mortgage broker can work with any of the traditional banks as well as a long list of other lenders to find the product that works best for you.

A-Lenders

Canada’s “Big 5” banks [TD, RBC, CIBC, Scotia, BMO] are what we call “A-lenders.”  These banks are regulated at the federal level, and they offer mortgage loans to customers with good credit scores and a reliable stream of income.  Borrowers must pass the federal stress test to qualify.

Some Credit Unions also cater to an “A-clientele.”  Their regulation is provincial, but their lending criteria is equally stringent and their mortgage approval process is just as thorough as the bigger banks.

Still another category of A-lender is the monoline lender.  This is a company that deals only in mortgages,  with a streamlined process and low overhead.  They tend to market themselves to mortgage brokers instead of going directly to the consumer.  You’ll often get very attractive interest rates and excellent terms from these lesser-known (by the public) institutions.

A-lenders have a very detailed application process and high standards for their applicants.  This is why A-lenders are able to offer the lowest interest rates.  This is also the only type of mortgage available to buyers who have less than 20% toward a down payment.

B-Lenders

A common alternative for some applicants is to use a “B-lender.”  Companies like Home Trust and Equitable Bank offer financing options to buyers who don’t meet the stringent requirements of ultra-traditional lenders.

B-lenders are regulated, reliable, and quite popular.  In today’s gig-economy, more and more people are self-employed.  B-lenders are more flexible in the way they consider income, making it easier for entrepreneurs to qualify for a mortgage.

They may also offer options for recent immigrants and those with less-than-stellar credit for any of a multitude of reasons.  As long as you have at least a 20% down payment, B-lenders may be an excellent option.

Expect to pay a slightly higher interest rate on a B mortgage while keeping it affordable.

Private Lenders

This is almost always a last resort.  Unless the private mortgage is between you and a wealthy relative and is based on a personal relationship-this will be a high-interest loan.

Private loans come from individuals or groups who pool their funds for this purpose.  Interest rates are always high and there are typically up-front fees that could be in the range of 2-4% of the cost of the loan.  This means that you would have to pay $10-20k just to get a $500,000 mortgage in place.  Besides your own legal fees for the transaction, you’ll have to pay the legal fees to register the loan for the lender as well.

Often, a private loan of this type is a short-term agreement, 6 months or a year long.  Payments might be interest-only.

Buyers who need this type of mortgage are usually in a temporary bind of some sort. They may be working to raise their credit score, going through a period of unemployment, a divorce, or some other set of circumstances that will change in the near future.  As these loans are considered high-risk, you’ll have to have a substantial down payment with ratios that are acceptable to your particular lender.

This sector is unregulated and it’s wise to have your lawyer review any contract before you sign.

Even within the same category of lenders, you will find multiple mortgage products and different interest rates.

High-ratio or Conventional?

Without getting too detailed, there are two basic types of mortgages:

• A conventional mortgage is uninsured.  The buyer has a minimum of 20% down payment, and the mortgage is for 80% or less of the value of the property.
• A high-ratio mortgage is insured by a company like CMHC, Sagen, or Canada Guaranty.  This incurs additional monthly costs.

At the point of going through your mortgage approval process, if you need mortgage insurance, know that any deal will need to be approved by both the lender and the insurer.   CMHC has some qualifying criteria of its own that you’ll have to meet.

What You Need Before You Apply

The whole mortgage approval process can be tedious, especially if you’re not extremely well-organized with your personal paperwork. You’ll have to produce a long list of documents to prove your financial status, including:

• pay stubs
• employment letter
• Notices of Assessment and two or three years of tax returns if you’re self-employed
• proof of down payment + closing costs (bank statements)
• list of assets (savings, RSP’s, cars, boats, other real estate, etc)
• proof of current debts (credit cards, lines of credit, personal loans, student debt, etc)
• details of financial obligations (spousal or child support)
• leases and rental agreements
• ID

If your application meets the underwriting guidelines, the lender will issue a commitment letter.  This letter is usually conditional.  Read it through carefully to find out what loopholes there might be for the lender to pull the financing before closing.  This is especially important if you are putting in a firm offer without a financing condition.

Then I’m done, right?

Once your application gets processed, you will know how much of a mortgage you qualify for.  But you’re not quite done yet.

There are two parts to mortgage approval:

1. Your financial status
2. The property you want to buy

Since the lender essentially becomes part-owner of the property with you, they reserve the right to appraise and approve the actual asset (the property).

The appraisal is one issue that could become a pitfall.  The bank might qualify you to borrow $500,000 (based on your finances)- but only if the house you want to buy appraises for at least $625,000 and meets their criteria.

Remember, A-and-B lenders only want to lend up to 80% of the value of a home for a conventional mortgage.

If you get caught up in a bidding war and end up paying a price that’s higher than what the lender will support, you may have to increase your down payment.

Here’s an example:

You buy a house in competition and pay $640,000.  The appraisal comes in at $625,000.   

The lender is willing to lend only $500,000 on a conventional mortgage.  Anything over that requires mortgage insurance through one of the companies mentioned above, and will incur fees.

Your down payment will need to be $140,000 or more to avoid these fees.

Other things that could affect your funding are a change in your employment, financial, or credit situation, or the discovery of something about the property that disqualifies it. (For instance, if the house is found to be uninsurable.)

Talk to your mortgage broker to find out what you need to know about the mortgage approval process before putting in offers. 

This is the best way to protect yourself from ugly surprises when it comes to financing.

What Sellers Should Know Before Accepting an Offer

In a hot sellers’ market, you want to get the most money.  That’s a given.  But take a look through the information for buyers who need a mortgage.  Who your buyer is really matters because if their financing is not solid, your deal could fail.

As you sit around the table looking at multiple offers, try to remember that the highest offer is not always the best offer.  And even a firm offer, if it isn’t supported by solid financial backing, isn’t always the best offer.

Your realtor needs to ask questions about the buyer.  Are they pre-approved? How much of a down payment do they have? Do they have parents or others who can help them if they have a shortfall?  Do they have a property that they need to sell before they can buy yours?

Once you have a better idea of who is making the offers, you will be in a better position to know which one to accept.  You’ll be glad you did on closing day!