So, you can afford your desired mortgage payment, but do you qualify for it? There are a lot of factors that a lender considers when deciding to give you a mortgage. There’s a difference between knowing you can afford a mortgage and actually qualifying for one.
Recently, there was another round of changes to the rules that banks use to qualify you for a mortgage. But what does that mean? It doesn’t mean you’re shut out of the real estate market completely. If you have the income and a steady job, it just means you have to be a little more careful with your debt load. Lenders will look at two factors and five variables to determine whether you qualify for a mortgage loan. In the industry, the common terms for these variables are the Five Cs of Credit. If you pass the credit test, the industry also looks at a couple of ratios that must fit to qualify for the mortgage loan. It’s these ratios that have been most affected by the changes.
The first two factors are your ability to make your mortgage payments and your willingness to make those payments. These two factors are then categorized into the five variables. They are:
Capacity: Can you repay the mortgage loan? This is the most important of the five. A lender will look at your credit report and review your debts to see if you’ve paid them on time. Lenders don’t like to see missed payments consistently, which sends a message that you may be over your head with your debt load. Lenders also don’t like to see too much debt and/or maxed out credit.
Capital: This is the amount of money you have to invest in the property yourself. Lenders don’t like to take all the risk. So, make sure you have at least the minimum down payment. That down payment can come as a gift from a family member or can come from a bank loan or a line of credit as long as you can manage the extra debt.
Character: Okay, this is a grey area: It’s an impression of your trustworthiness. It’s the big picture. Lenders look at how long you’ve been employed and how secure you are. They will also look at your ability to save and manage your credit.
Collateral: Yes, your cash flow is important but so is the property you’re buying. The house is pledged as security for the loan. Collateral can also come from a third party who will guarantee the loan.
Credit: This is your credit history – how long have you been using credit. The more years you’ve been an active credit user the better.
Now, on to the ratios. There are two critical ones that lenders use that determine your ability to service your debt – your gross debt service ratio or GDS and your total debt service ratio or TDS. To qualify for an insured mortgage loan, or high-ratio mortgage, your GDS cannot be higher than 35% of your gross income. GDS is the amount spent on housing — principal mortgage payments, interest, taxes and heat. The TDS includes all your debt and cannot be higher than 42 per cent of your gross income.
If you opt for a fixed rate, which today can be had for less than 3%, you’re relatively safe throughout the term of the mortgage, and as long as you opt for a five-year term, you are qualified on that rate. But if you decide you want a variable rate, which is sitting as low as 2.4%, you will have to qualify at the lender’s benchmark posted rate, which now 4.79%