Before you start house-hunting, first you need a mortgage pre-approval. It might sound a little backwards but there's a reason you need one before you do anything else. Applying for a mortgage pre-approval is like asking your lender to go steady. It’s kind of a big deal. If you want a mortgage lender to swipe right on your application then you need to make sure you are mortgage material. But what is a mortgage pre-approval, why is it important, and how do you get one? Here's everything you need to know about mortgage pre-approvals in Canada so you can snag your dream home and live happily mortgaged.
What is a mortgage pre-approval?
Most mortgage lenders in Canada offer mortgage pre-approvals to homebuyers. It has become a critical part of the homebuying process. In fact, most real estate agents won't even begin showing homes to clients until they have a mortgage pre-approval in hand.
A mortgage pre-approval happens when a mortgage lender has assessed your financial situation and creditworthiness to determine whether or not they will finance a mortgage for you. It involves almost all the stages of a full mortgage application. The difference between a mortgage pre-approval and full mortgage application are the details relating to a specific property. Instead of submitting an offer to purchase, then applying for a mortgage loan after the fact, you are actually applying to see if you are in a position to buy at all.
Both your credit history and all your financial information are used to determine whether or not a lender is willing to finance your home purchase. If you are pre-approved for a mortgage, you are given a formal letter from the lender that indicates the maximum mortgage amount the lender is willing to finance, as well as the mortgage interest rate you qualify for. It is an important first step towards a full mortgage approval.
However, it doesn’t guarantee that you'll be approved for a mortgage on a specific property; just that you meet the lenders qualification criteria for financing. When you find a house you want to buy, you'll submit an offer to purchase. Then you'll provide all the necessary property information to your lender. Your full mortgage approval will depend on the property meeting the lender’s criteria. Then, at the time you are ready to apply for the full mortgage, the lender will check to see if your finances have changed since the pre-approval.
Thinking of buying a house? Use the Hardbacon Mortgage Calculator to find out if you can afford a mortgage.
Is a mortgage pre-approval the same as a mortgage pre-qualification?
No, they are not the same thing. A mortgage pre-qualification is a less formal process, but it doesn’t come with any guarantee that you'll actually qualify for a mortgage. The lender, or broker, will ask you some questions about your financial situation but won’t ask for any documents, nor will they perform a credit check. A mortgage pre-qualification only gives you and idea of how much you might qualify for. Whereas, a mortgage pre-approval is basically the lender saying “yes, we'll mortgage you. As long as you remain financially faithful and the property meets our standards.” A pre-qualification is like a promise ring, and the pre-approval is like an engagement ring.
Having said that, a mortgage pre-qualification is still helpful. At the very early stage of your home buying journey it’s a good way to figure out what you might be able to afford so you can plan your down payment and price range accordingly. But it doesn’t give you any certainty. Keep in mind, most realtors won’t accept a pre-qualification as evidence that you’re in a position to buy. When you're actually ready to start house hunting, that's when you'll need a mortgage pre-approval in hand.
Why is a mortgage pre-approval important to have?
A mortgage pre-approval prevents you from getting your heart broken later on because it tells you ahead of time how much house you can actually afford. That's important to know before you start house hunting to avoid costly and embarrassing surprises. As long as your circumstances haven’t changed, and you are buying a property that meets the lender’s criteria, the formal mortgage approval process should relatively quick and easy, depending on the property you've chosen.
The benefits of a mortgage pre-approval are:
- You know exactly what you can afford and what your mortgage payments are likely to be
- You know what size down payment you need
- The mortgage interest rate is typically locked-in between 60-130 days from the date of pre-approval, affording you time to hunt for the right house without fear of rates going up
- It demonstrates to realtors and sellers that you are in a good position to close the deal, which makes your offer more attractive than other buyers
- It speeds up the formal mortgage application process because you have already provided all your credit and financial formation to the lender
- It costs nothing. Most mortgage lenders will not charge you anything for a mortgage pre-approval
Without a mortgage pre-approval, you run the risk of falling in love with a house you can't actually afford; your mortgage application gets denied and the offer to purchase falls through. When that happens, nobody is happy. And it can actually cost you money.
It is industry standard to submit a deposit along with your offer to purchase. The deposit demonstrates to the seller that you are a serious buyer. In the event you withdraw your offer, you lose your deposit. The amount of the deposit is a percentage of the purchase price, and varies from province to province. This is not an extra cost you need to come up with, it is considered part of your down payment. If you don't have a mortgage pre-approval before submitting an offer to purchase, you run the risk of losing that money if the lender rejects your mortgage application.
Once a lender swipes right on your mortgage pre-approval, the fun of house hunting can begin! You'll be able to shop for houses you're actually qualified to buy. That narrows down your search and avoids embarrassing moments; like when your agent has to update the seller that your financing fell through. Hashtag awkward. It also saves you money.
Where can I get a mortgage pre-approval?
The importance of a mortgage pre-approval cannot be overstated. Luckily, there are a few different ways you can get one. Let's take a look.
There are many websites that help you compare several lenders at once. Start with our Mortgage Comparison Tool to find the best lender for your needs. We do all the all the heavy lifting, all you have to do is answer a few simple questions. Well help you find the right mortgage lender for your needs in under 2 minutes.
You may be familiar with Canada's big 6 banks, but they're not the only ones who can finance your mortgage. There are several other kinds of lenders who offer mortgage pre-approvals and financing, such as:
Not all lenders are the same. They all have different different qualification criteria when it comes to things like credit scores, loan amounts, type of property, and mortgage interest rates. It's important to shop around to find the right kind of mortgage for your needs. Just because one lender says no doesn't mean they all will.
Mortgage brokers are not lending institutions, they are a middle-man whose role is to find the most suitable lender for you. They can offer you a mortgage pre-approval from one or more of the lenders they work with, which varies from broker to broker. One of the main benefits of a mortgage broker is that you don’t need to spend time trawling the market for the best lender, or the one who will offer you a pre-approval. The broker will do this for you based on the information you provide.
Broker's don't normally charge a fee for their service. That's because they usually receive a commission from the lender for a successful referral. Different brokers have different lenders in their network. Some broker's may only work with a very small number of mortgage lenders. It’s worth asking a broker which lenders they have in their network before using them.
How can I improve my chances of getting a mortgage pre-approval?
Clean up your credit and pay down your debt, its that simple. In Canada, the bare minimum credit score required to qualify for a mortgage is 600. However, basement-level credit scores come with sky-high interest rates. If you want to get approved by traditional lender with a competitive interest rate, you’re looking at a credit score of 680 or higher. Then, you need to pass the mortgage stress test, more on that later. But first, your credit score.
Why you should increase your credit score
A strong credit score is made up of on-time payments, up-to-date credit accounts, minimal debt balances, and clear of collections or judgements. A strong credit score will boost your chances of getting a mortgage pre-approval and it can literally save you tens of thousands of dollars in interest. Don’t believe us? Here’s an example:
Let’s pretend you have a credit score of 600 and one of Canada’s major banks pre-approves you for a $350,000 mortgage at a 3.5% interest rate amortized over 25 years. Assuming your rate and payment never change, you will end up paying over $175,000 in pure interest charges.
Now let’s say your credit score is 595 and a private lender pre-approves you for the same $350,000 mortgage amount over a 25 year amortization period but for a slightly higher rate at 4%. Over the life of your mortgage, you will end up paying over $204,000 in interest charges. In this scenario, a lower credit score bumped your interest rate by just half a percent which cost you almost $30,000 in additional interest. Yikes!
If you have some blemishes on your credit file that are tanking your score below 680, you should really work on cleaning it up so you have the best possible chance of getting pre-approved for a mortgage at the best possible rate. Start by settling up any collections or past due accounts, pay down your debt starting with credit card balances, and make all your payments on time every month without fail.
Why you should pay down your debt: the stress test
When lenders are deciding whether or not to pre-approve you for a mortgage, they’re not just looking at your credit score and how much money you make. They’re also running careful calculations to make sure you can afford the mortgage, the associated costs of homeownership, and the general cost of living.
In Canada, all federally regulated lenders, like the big 6 banks, are legally required to make sure you can afford your mortgage payment with the interest rate they're offering you, as well as a pretend higher rate. This is called the “mortgage stress test” and it's designed to make sure homebuyers can still afford to make their mortgage payments should interest rates go up in the future. Believe it or not, this is for your own protection. You don't want to lose your house if you suddenly can afford the mortgage payment because the rates shot up, and your lender doesn't want to take it from you either. The mortgage stress test is meant to help protect all parties involved.
The stress test analyzes your financial information to determine your ability-to-pay. This is more commonly known as your debt-to-income ratio, which is determined through two equally important mortgage-math calculations:
- Your Gross Debt Service (GDS) is your total before-tax monthly income measured against your potential mortgage payment, property taxes, utility bills and condo fees, if applicable. Lenders are looking for a total GDS score of 39% or less. That means you should not be spending more than 39% of your total monthly income on housing costs.
- Your Total Debt Service (TDS) measures your total before-tax monthly income against your housing costs plus all your other monthly debt obligations like student loans, cars, credit cards, etc. Lenders are looking for a total TDS score of 44% or less. That means you should not be spending more than 44% of you total monthly income on housing costs and debt repayments.
So what does this have to do with the stress test? Everything! Federally regulated lenders are legally required to run a “worst-case scenario” test to make sure you can handle a higher mortgage payment should interest rates rise in the future. They do this by calculating how much your mortgage payment would be using a benchmark rate of 5.25% or prime plus 2%, whichever is higher. But why do they have to do this?
Remember, rates are not locked in for the life of your mortgage, called the amortization period. If you choose a fixed-rate mortgage, the interest rate is only locked during the term you've chosen which is anywhere from 6 months to 10 years. Your mortgage term will come up for renewal several times over the amortization period. If you choose a variable-rate mortgage then your payment is subject to the constantly changing interest rates. Either the amount you pay will fluctuate month to month, or the payment amount will stay the same but the amount that goes to interest versus the principle will change as the rate changes. Either way, the lender is legally obligated to make sure you can handle a higher payment should interest rates increase.
They do this by comparing that fictitious higher payment against your current GDS and TDS ratios. If that higher payment pushes your GDS over 39% or your TDS over 44%, you’ll fail the mortgage stress test won't qualify for a mortgage. You may have to consider applying for a mortgage pre-approval through a credit union or private lender. Be wary of private lenders, though, they typically charge much higher mortgage interest rates.
Will you pass the stress test? Use the Hardbacon Mortgage Qualifier Calculator to get your GDS and TDS ratios.
The mortgage stress test in action
You’re applying for a joint mortgage with your significant other. You both make the Canadian average salary of $52,000 a year each which puts your gross monthly household income at roughly $8,700 a month. You’re applying for a $350,000 mortgage and your lender gave a mortgage pre-approval with a 3.75% interest rate and a 25-year amortization.
Your mortgage payment would be about $1,800 a month. Together, you and your partner are paying $1,300 a month total to debts like your student loan, car and a few small credit cards. The property taxes are estimated at $3,500 a year, which is $292 a month, and a house of this size typically costs an average of $200 a month in utilities.
The mortgage payment coupled with property taxes and utilities gets subtracted from your gross monthly income. That puts your GDS ratio at 26%. That means for every $1.00 you make you are paying $0.26 to your potential housing costs. Put another way, only 26% of your total household income is being used to pay for housing. Great! That means you passed the GDS test because its under the 39% limit.
But now the lender has to factor in all your other monthly debt obligations like your student loan, car and credit cards. Your monthly debt payments are added to your potential monthly housing costs which put your TDS ratio at 41%. Fantastic! At the current mortgage interest rate of 3.75% the lender has offered, you’re pre-approved for a mortgage. Almost.
You’re not out of the woods Yet!
Now it's time for the stress test, and they don't call it stress for nothing! The lender now has to apply either the benchmark rate of 5.25% or prime plus 2%, whichever is higher, to the exact same mortgage amount and amortization period. At the benchmark rate of 5.25%, for example, your mortgage payment would be $2,100. That bumps your GDS ratio up from 26% to 30%. Ok, that's not so bad. But uh oh! Your TDS ratio got pushed from 41% to 45%. The cut off is 44%. Womp, womp.
You just failed the CMHC stress test all because of a mere $300 difference between the two mortgage payments. That’s why it is so important to pay down as much debt as possible before applying for a mortgage. The debt you’re carrying can quite literally be the deciding factor on whether or not you qualify for a mortgage, even if you have perfect credit.
So now your options are to put off buying a house until you can pay down your debt, adjust your price range and apply for a smaller mortgage, or keep saving until you can provide a 20% down payment. But let’s be realistic, in some housing markets that’s not always possible.
Can I avoid the mortgage stress test?
You can, but you shouldn't. Since Canada’s Big 6 Banks are federally regulated they are legally required to apply the stress test to your application. However, credit unions, and private alternative lenders that are not federally regulated don’t have to run the stress test. Having said that, you’ll be hard-pressed to find a credit union that doesn’t use the stress test as part of their approval process. Why?
Because it’s just good business. It ensures they are granting mortgages to those who can truly afford them. It’s also because credit unions are risk-averse. Risk what?
They don't like taking chances. Credit unions are less willing to take on riskier mortgage borrowers for the simple reason that they are considerably smaller than banks; loss hits their bottom line a lot harder. In order for them to stay in business, they need to remain profitable. So they must be extra careful when lending.
But other private lenders, like subprime mortgage companies, do not have to follow stress test guidelines either. Proceed with caution, though. Because they can lend to much riskier applicants, their mortgage interest rates are astronomically higher. It’s not uncommon for private lenders to charge mortgage interest rates in the double digits. If the only way you can obtain a mortgage is to go through a private or subprime lender, you really shouldn’t be getting a mortgage at all. That’s a really tough pill to swallow, but the truth hurts sometimes.
I need to get a mortgage pre-approval, how do I get started?
You've crunched the numbers and you're ready to commit. Now it's time to pop the question to a lender, or a few of them. But they need to size you up to make sure you're mortgage material. Here's how to go about getting a mortgage pre-approval:
Shop around first
Before booking your mortgage pre-approval appointment you should shop around for the best mortgage for your needs and compare interest rates first. Knowing ahead of time who’s offering the lowest mortgage interest rate will help you narrow down where you’d like to do business.
The best place to start is with an online comparison site, like the Hardbacon Mortgage Comparison Tool. Just answer a few quick questions about the type of property, your price range, and how soon you plan on re-selling. Then, Hardbacon will generate a list of lenders offering the most competitive mortgage interest rates, the term, and monthly mortgage payment. Keep in mind, you’ll need a pre-approval appointment to not only find out if you actually qualify but also your exact rate and a more accurate mortgage payment estimation as well.
A great strategy is to use both an online comparison tool and a mortgage broker. Each will have partnerships with different lenders that they work with. Using both will give you an excellent picture of all the different lenders out there and what they’re offering. If you aren’t a typical buyer because you are self-employed or have a weaker credit file, like a past bankruptcy for example, a broker can help connect you with alternative lenders who take on atypical homebuyers.
Book a mortgage pre-approval appointment
Now that you’ve found some attractive suitors, I mean potential lenders, you need to call and book a pre-approval appointment. In this appointment, the lender will assess your financial profile to determine how much of a mortgage you can afford, as well as the mortgage interest rate. If you’re pre-approved, your rate will be locked in and guaranteed anywhere from 60-130 days.
At that point, you can start contacting real estate agents to begin house hunting. Since the rate is guaranteed for a specific period of time, you’ll have peace of mind knowing you won’t get hit with any surprises should the rates increase while you’re trying to find the perfect home.
The pre-approval process is faster and easier the more prepared you are. Since the lender needs to assess your full financial profile, you’ll need to make sure you have all the required documentation ready to go. To get started, you’ll need:
- Photo identification: Like your driver’s license or passport. If you’re using your passport, be prepared to provide secondary documentation like a utility bill or bank statement with your name and address on it.
- Social Insurance Number: In order to pull your credit file to assess your creditworthiness, your lender will need your Social Insurance Number (SIN). If you’ve ever applied for credit in the past then you know this is standard practice. Your SIN is used to ensure the correct credit file has been pulled. There are 8 billion other people on the planet; somebody is bound to have the same name as you, but none of them will have your unique SIN number. This will help avoid any errors or hiccups that could slow down or complicate the application process.
- Financial documents: You’ll need your banking and investment statements, pay stubs, employment verification letters, tax returns, and sometimes your Notice of Assessment (NOA) if you’re self-employed or have additional income streams. You also need to provide other documentation proving your assets and liabilities like any cars, boats or cottages you might own, as well as all your debt like credit cards, lines of credit, student loans, etc.
- Proof of down payment: Some new home buyers may not be able to afford a down payment by themselves. It is not uncommon for parents to help their children with the purchase of their first home. If you down payment comes from a source other than your own savings account, you’ll need to declare the source of the funds and whether or its a gift or a loan. Some lenders will not finance a mortgage if the down payment is borrowed.
What your mortgage pre-approval means and what it doesn't mean
Once you’ve received your mortgage pre-approval, it's important to understand what it does and doesn’t mean when it comes to buying a house. The mortgage pre-approval only means the lender has confirmed you fulfill the qualification requirements, you've passed the stress test, and that they're willing to finance a mortgage with specific conditions.
It doesn’t mean that the house of your dreams will automatically be approved. Once you find a house and submit an offer, that’s when the real financial heavy lifting starts. Lenders have very specific parameters around what kind of properties qualify for a mortgage and which properties don’t. Here are a few things that can kill your actual mortgage approval:
- Value: In order for a lender to approve your mortgage, the property needs a professional appraisal to ensure the list price reflects the true value of the property. It’s not uncommon for an appraisal to come in under the list price.
- Property Type: Not all lenders finance all properties. For example, some lenders won’t finance mobile homes older than 1985, while others just won’t finance them at all. Some have other stickler requirements about whether or not it’s on wheels or a foundation. And, despite their growing popularity, banks won’t finance a tiny home with a traditional mortgage. Those require an entirely different kind of loan altogether
- Location: Lenders also have stipulations on where the property can be located. If your lender is a credit union, for example, depending on the size and number of branches they may not finance mortgages outside a certain radius from where they are located, known as the trade area. Since credit unions are provincially regulated, meaning they cannot operate outside their respective province, an Ontario based credit union cannot finance a mortgage for a house in Alberta or BC, for example. If your lender pre-approved you for a mobile home, there may also be restrictions about the land. Many lenders will not finance mortgages for mobile homes on land you don’t own. So if the land is leased, your financing could fall through. Still, others won’t finance properties on lakefronts or in regional parks.
What if I get turned down for a mortgage pre-approval?
If you get turned down it might be because your credit score or income source doesn’t meet the lender’s qualification criteria. Ask your broker or lender the reason and then consider whether you should try elsewhere or postpone the property search until you can improve your situation.
There might be a reason that is easily rectified, such as incorrect information on your credit file, which happens more often than you’d expect. Or perhaps you have an unconventional job or source of income that is hard to verify. In that case, you may need to provide more documentation in order to prove your income.
What if I was pre-approved for a mortgage, but rejected for the actual mortgage?
If this ever happens to you its usually because one of two things occurred, or both: your financial situation changed since your mortgage pre-approval, or there's an issue with the property you're trying to buy. It’s important to avoid taking on any more debt, or changing jobs, after getting your mortgage pre-approval. Changes to your financial situation will mean the lender has to re-assess you and effectively start the approval process all over again.
Then, when you submit an offer on a property you want to buy the lender has to asses whether it meets their requirements before they'll accept it as security against your mortgage loan. The lender will have the property professionally assessed and valued. Sometimes they’ll decide the property value is less than the asking price. Or there might be structural issues that cause them concern. If that happens, they'll reject your mortgage application. You'll either need to withdraw your offer and lose your deposit. Or test your luck with a different lender, which could complicate your offer.
Think about your mortgage approval as two separate parts: first, an assessment of you as a borrower. Second, an assessment of the property as security for the mortgage loan. Your mortgage pre-approval covers the first part but the second part has to be approved during the formal mortgage application.
Just like any other relationship, honesty is the best policy, and when it comes to your financial profile, good character is next-level sexy. It’s not just about ticking the right boxes like good credit and stable income. There are important aspects of your financial situation that fall outside the scope of your application.
You need to be honest not just with your lender, but with yourself too. Do you struggle with overspending? Are you planning on changing jobs? Are there rumors of company-wide layoffs? Would you like to have children in the future?
These are the kinds of serious questions you need to ask yourself before you pop the question by submitting an application for a mortgage pre-approval Getting married can be scary, but getting mortgaged doesn't have to be. As long as you are honest, committed and ready to put in the work.
There’s a lot to be said about an applicant who has dedicated considerable time and energy to rehabilitating their credit file and preparing for the serious financial commitment of homeownership. Do that, and any lender would be lucky to have you.