Surprisingly many prospective homeowners start applying for mortgages without having an idea of how their creditworthiness and risk are calculated by financial institutions.
This can have a major effect on your interest rate and how much you will ultimately have to cough up for your home. As such, knowing how mortgage lenders establish your creditworthiness and risk profile can help you get a clearer picture of what your mortgage will look like and avoid nasty surprises.
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Housing expenses vs income ratio
This is one of the most basic factors lenders take into account to determine how capable you are of repaying your loan or mortgage. It’s generally recommended that no more of 30% of your gross income (after taxes) should go to your housing costs. These costs include either your mortgage (or rent), your property tax, and your home insurance.
Most Canadian lenders maintain a maximum 28% of housing expenses to income requirement. This can vary between individual lenders as well as your personal circumstance. A very good credit score can offset this amount slightly. The 50/20/30 rule, where 50% of your income goes to fixed monthly expenses (housing, debit orders, etc.), 20% goes to variable monthly expenses (groceries and entertainment), and 30% goes to savings, is considered to be a good profile.
Debt-To-Income ratio (DTI)
Some people may have more than one big loan they are paying off at any one time. It could be various mortgages, a loan for a business venture, student loans or a loan for that fancy new car of yours.
Any lender will pay close attention to your accumulated debt and measure this against your income to determine whether you can take on more debt. If you know you might need a mortgage, it might be best to hold off on any big loans until that time. It might also help to try and break some of your loans early.
Most lenders will require that your housing expenses we talked about previously and your monthly repayments together come to no more than 36%. That means you only have another 8% of debt-wriggle-room on top of your housing expenses.
The initial down payment you make no doubt has a big influence on the bottom-line of your mortgage. Cutting 20% off the top of your principal puts a big dent in the amount of interest you will need to pay. So, having this kind of money available is obviously a big plus.
If you have made some solid investments and have a good and diverse portfolio, it also lessens the risk you are at to fail to make your payments.
There are a few factors that lenders consider here:
- Credit score: Your overall credit score is obviously one of the most important factors that give many sleepless nights. 750 plus is considered an excellent score that will get you the best rates. 680 will qualify you according to most lenders whilst a score of 600 or less disqualifies you from almost any traditional financial institution.
- Credit mix: This is the type of things or reasons for why you have purchased on credit before. This could help them establish how likely you are to go into more debt or how responsible you are.
- Credit history: Obviously, the longer your credit history is, the clearer picture a lender can get of you and gives them an idea of your consistency at repaying debt.