Applying for a mortgage in Canada can be a difficult process – it has to be. Your mortgage is likely going to be the largest loan you will ever take out in your life, so you need to do it right.
This is not a complete guide to everything that you need to know about mortgages in Canada. Instead, we want to go through the most common concepts that people often find tricky to understand when it comes to mortgage loans and qualifications, like the Canadian mortgage stress test, for example. Hopefully, by the end of this piece, you’ll be better informed about the things you need to take care of before applying for that loan.
Your Credit Score and its Impact on Mortgage Approval
While your current income and financial standing will have a major impact on whether you are approved for a mortgage or not, a good proportion of the lender’s decision-making process will focus on your credit score. After all, your credit score is a representation of how reputable you are as a borrower (e.g. Do you pay back on time? How many loans do you have?). And since the lender is handing you a large sum of money, they need to know they will get their money back.
It’s easy to look up your credit score, so we won’t go into that anymore. However, we do want to answer the number one question asked by first-time mortgagors: what is the best credit score for a mortgage?
Ideally, it should be at least 600. Anything under that, and you will find it tricky to obtain a mortgage. It wouldn’t be impossible, just incredibly hard, and you will need to jump through a lot of hoops and pay huge interest rates. So, if you are under 600, try to make improvements to your financial health before you apply.
Mortgage Down Payments
Canada is one of the countries that regulate minimum mortgage down payments at the federal level.
If you are buying a home valued under $500,000, then the minimum downpayment is 5% of the purchase price. Between $500,000 and $1 million, it is 5% for the first $500,000 and then 10% for anything on top of that. If you buy over $1 million, then you need to pay 20%.
Now, here is where things get tricky for a lot of people. While the minimum downpayment is 5% (in most cases), it isn’t recommended that you apply for a mortgage at this rate. For starters; it is nigh on impossible to get approved if you can only pay 5% upfront. Your loan will also end up being a lot more expensive if you do this.
When you start the search for a property, you might want to obtain a mortgage pre-approval. This is the lender telling you how much they will likely be able to offer you if you take out a mortgage through them. If you have been pre-approved for a certain amount, this does not mean that you are 100% guaranteed the mortgage. The lender will need to look at the house you’re buying and carry out a few checks on your finances before they hand you the cash.
It is important to note that a mortgage pre-approval will only last for a certain period of time, depending on the lender. Some will typically give you 60 days and others, 120 days. At the end of this time period, you will need to reapply for the mortgage. This could result in a higher or lower interest rate. You can do your research and find the current RBC Royal bank mortgage rates to get a better idea of the costs.
The Mortgage Stress Test
In 2018, the mortgage stress test was introduced. In the past, if you wanted to obtain a mortgage, most lenders would simply look at your credit history and current finances. They would then determine whether you can afford the rates they’re offering, and if you can, they would likely offer the mortgage to you.
The mortgage stress test is designed to see whether you are able to afford your mortgage in the event of a dire financial situation. Such situations could be a sharp rise in interest rates, or if you lose your job. The idea is to ensure that people are not thrown into a financial hole should the worst happen.
In a way, the mortgage stress test aims to check how financially fit you are. It’s supposed to act as an additional safeguard against defaulting on your loans. Now, the stress test comes with a bunch of terms and conditions that merit its own separate article, so we’re not going to go into detail about how it works. However, we’ll give you one tip to improve your chances of being approved for a mortgage, and that’s to ask to borrow less than you can currently afford. The less you need to borrow, the higher the chance of you passing the stress test.
That being said, you can avoid the stress test completely if that’s what you’re planning to do. Only federally-controlled banks are required to offer it. If you want to skip it, you can choose to apply for a mortgage from an alternative lender.
Types of Mortgage
We want to wrap this up by giving you a brief overview of the different types of mortgage. It is important that you choose the right mortgage type for you, whether you are working with a bank or an alternative lender:
- Closed Mortgage: With this type of mortgage, you will be given an interest rate that is fixed for a certain amount of time (usually five years). At the end of the term, the interest rate will be recalculated. This is the best option for those who want to know the exact amount of money they will be paying each month.
- Open Mortgage: In many ways, an open mortgage is much the same as a closed mortgage. However, there is one major difference: you can make repayments whenever you want. Of course, there will be a fixed amount you need to pay each month but, if you wish, you can pay a larger sum of cash, or even pay off your mortgage completely. These mortgages will often have a higher interest rate.
- Convertible Mortgage: These are quite rare now, but if you can find one, you can think of them as a hybrid of a closed and an open mortgage. For the most part, they will be open (and thus you will be subject to changing interest rates). But you can fix the interest rate whenever you wish, which will convert it into a closed mortgage.
Getting your first mortgage is a milestone – one that you should adequately prepare for. Aside from exploring all your options and comparing the best mortgage rates (you can use resource sites like Rate Genie for this), it’s important to ensure that you’re truly financially prepared to undertake such a big responsibility.