BUSINESS
02/28/2020 06:27 EST

How Does A Mortgage Pre-Approval Work When Buying A Home?

This free first step available online lets you know how much you can afford.

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A financial adviser meets with clients in this stock image. It's best to reveal any outstanding debt when getting a mortgage pre-approval as a credit check will uncover them.

Buying a home can be as exciting as it is nerve-racking. Luckily, you can keep calm about locking in a decent mortgage rate while you carry on with your house-hunting by getting a mortgage pre-approval.

A pre-approval is the first step in buying a home, giving you certainty around what you can afford and helping you move faster when making an offer. Here’s a step-by-step guide on how to get a mortgage pre-approval. 

A pre-approval shows how much a lender, such as a bank or credit union, is prepared to loan you and what it will cost. It not only tells you how much of a mortgage you can afford, it’s proof from the lender that you can qualify for that amount given your current income, expenses, debts and credit score. It also lets you hold a mortgage rate and tells you how much your mortgage payment will be at that rate. 

Four main factors affect whether you’ll be pre-approved for a mortgage loan, how much you’ll be offered and the rate given. 

Credit score: The higher your credit score, the better your odds are of getting pre-approved for a better rate. Having a score of at least 680 increases the chance you’ll get a great rate.

Down payment: You’ll need a minimum of five to 20 per cent of the property’s purchase price for a down payment. Therefore, your down payment can limit the maximum mortgage amount you can qualify for. The more you have saved up, the better.

Debt service ratio: Your debt service ratios allow lenders to see the percentage of your income that will be used to pay off your debts and expenses. Lenders calculate your gross debt service ratio (GDS) and total debt service ratio (TDS) to determine how much you can afford to borrow. The lower the ratios, the more you can afford. You can decrease your GDS and TDS by paying off more of your debt, decreasing your major living expenses and increasing your household income.

Employment and assets: Lenders like a steady income, so full-time employment helps you get pre-approved. Some assets you own may also count toward your net worth and provide reassurance you’ll be able to pay back your mortgage.

Get it done in minutes

Pre-approvals are free. Your lender will need to qualify you for a mortgage at some point anyway, so it helps them to get started early.

If you have your documents together, you can even get a pre-approval within minutes online. It can take a couple of days if you need extra documentation. 

Watch: Here are trends you can expect in the housing market this year. Story continues below.  

 

There are plenty of benefits to getting pre-approved and they’re not just financial. Here are the five biggest advantages.

Helping you set a home-buying budget: While you might have a dream budget in mind, a pre-approval gives you a firm upper limit on what you can afford. This allows you to focus your house-hunting efforts on areas and properties within your means. 

Knowing the rate you can qualify for: Not everyone qualifies for the lowest advertised rates. A pre-approval tells you what rates you’re eligible for given your needs and financial situation.

Calculating your mortgage payments: A pre-approval not only tells you what rate and amount you qualify for, it also shows how much your monthly mortgage payment will be. This lets you know how much of your monthly income you’ll need to set aside for your mortgage and helps with budgeting. 

Guaranteeing your rate: Most lenders will hold your pre-approved rate for a specific period of time, usually between 90 and 130 days. If rates go up during this time period, your lender will honour your pre-approved rate. If rates go down, you’ll get a lower rate. This allows you to shop for a house without having to worry about rate changes. 

Moving quickly on an offer: A pre-approval shows sellers and realtors that you’re a serious potential homebuyer and have the finances to back up an offer. That can help you stand out from the competition and might be the difference between your offer being accepted or not. 

Before you take the leap

There are some important caveats to getting a mortgage pre-approval you’ll need to consider.

Credit checks: Pre-approvals will normally require a hard credit check. Your lender organizes this, so you don’t need to prepare anything for it. Don’t try to hide any outstanding debt, as this credit check will uncover them.

No guarantees: A pre-approval isn’t a guarantee you’ll be approved for a mortgage. However, if the home you buy meets the lender’s criteria and your financial situation is accurate throughout the pre-approval and mortgage application process, you shouldn’t have any issues. 

No obligation: Just as pre-approvals don’t guarantee mortgage approval, you’re also under no obligation to get your actual mortgage from your pre-approval lender. Even with a pre-approved rate, you should still make sure to shop for the current best mortgage rate once you finally find the home you want to purchase, as there are some promotional rates that aren’t available at the pre-approval stage. 

Budget vs. pre-approval: Your pre-approval amount is how much your lender will lend you, not how much you should spend. If you had a set budget in mind but suddenly learned you’re pre-approved for more, you could be swayed into looking at more expensive homes. Make sure to do your own math and decide what price makes sense for your financial situation. 

Though pre-approvals do not guarantee final mortgage approval, they are free and quite easy to get. They help you set your home-buying budget, allow you to plan your monthly spending, lock in a mortgage rate that protects you against rate hikes and let you move fast when you’re ready to make an offer. If you’re serious about home ownership, a pre-approval is the best place to start your journey.

At Ratehub.ca we make it easier for Canadians to choose better personal finance. With the best tools, rates and knowledge to help you take control of your money. Whether it’s a mortgage rate or insurance rate, a credit card, chequing account or high-interest savings account, we are your champions of choice.