Character, Capacity, Capital, Collateral and Conditions. Knowing how these five characteristics apply to your quest to buy a home will make you a better, smarter, and more prepared first-time home buyer!
If you ask a lender for a mortgage they’re going to want to know what kind of character you have. In other words, they want to know if they can trust you to pay back the loan. The main way a lender determines your character is by looking at your credit history.
If you pay a company for a loan or a service they are likely to send credit reports based on your payment history. There are credit reports for your mortgage, vehicle loan, cell phone, utilities, credit card and others. If you gave them your social insurance number when you signed up, they’re probably sending in credit reports.
Lenders, when you give them permission, can look at these reports to find out how often you make payments on time an if your accounts are in good standing. Each credit report also has a credit score between 300 and 900. Knowing your credit scores and details on your credit reports will help you figure out how to improve your chances of getting approved by potential lenders.
- Check your credit reports In Canada this is most commonly done with TransUnion or Equifax. This is the best way to find out which of your bills effect your credit. Make sure the reports are correct and be sure to report any errors. Also check for any credit reports from services you don’t recognize. This is a sign of credit fraud and needs to be dealt with immediately.
- Check your credit scores Each mortgage provider has its own scoring formula. But most mortgage brokers will look at both your TransUnion and Equifax data, so it’s important to understand both. With a general idea of your credit score in mind you’ll know what kind of position you’re in.
- Find lender information Some lenders will place credit scores into groups. Sort of a good-better-best range with individual rates. If you have a better credit score you’re likely to get a better interest rate. If your rate is in the “better” category but only a few points away from the “best” category it’s worth it to improve your score first before applying for your mortgage.
Capacity is your ability to repay your debt and is based off of your income and how long you have been at your current place of employment. Lenders will look at your recent tax return and pay stubs to measure your consistency and stability.
Lenders will also look at your debt to income ratio, also known as TDS (Total Debt Service Ratio.) Your TDS is a ratio of all your debt payments divided by your total gross income. This ratio is important to lenders because it tells them how much additional debt you may be capable of handling. Your TDS isn’t a primary aspect of calculating your credit score but it does impact your ability to get credit products like a mortgage.
To get your TDS start by tallying up your monthly debt payments. This includes things like credit cards, lines of credit, and other loan repayments. Then divide the total by your monthly pretax income. Your TDS should not be more than 44% (including your mortgage.)
- Bring down a high TDS ratio You can do this by paying off some debt or increasing your income.
- Build your savings If your TDS ratio is high you can make up for it with a large savings or liquid assets.
- Limit your home search In order to avoid a high TDS ratio you can limit your home search to properties with a price tag in your comfort zone rather than the maximum you can technically afford.
- Make sure you know the full cost of homeownership There’s more to the finances of a home than just the mortgage. Be sure you know what all your costs are going to be and how much. Read here for more information on this subject.
Capital is any investments, properties, assets and cash you have left over after the purchase of your home. It’s not a wise choice to leave yourself cash poor after buying a house. Having this kind of “cash cushion” gives lenders a bit of reassurance that you’ll be able to take care of your payments even if you hit a bump in your financial road, like losing your job or facing an expensive emergency.
- Find out what the bank wants to see Ask your lender how much money they want you to have in savings as your “cash cushion.”
- Find your own comfort zone Consider how much money you want to see in your savings account in the event you need access to it in an emergency or for regular home maintenance, like taxes and repairs.
Collateral is something of value that secures the loan should you be unable to maintain your mortgage. Meaning, if you don’t pay your mortgage the lender will be able to take something of yours to replace the cost of the mortgage. Usually in the case of a mortgage the collateral is the home itself.
If you only put 5% down on your house a home inspection is not common because your mortgage will be insured by the Canada Mortgage and Housing Corporation (CHMC.) If you want to avoid paying CMHC mortgage insurance you’ll have to put at least 20% down.
- Research collateral requirements Whether you are using a lender on their own, a down payment assistance program, or CMHC insurance, find out what the collateral requirements will be before you agree to the terms.
Conditions refer to things you can’t control, like mortgage rates, cost of living, and supply and demand. These are all things out of your control. The best thing to do here is research your options.
- Get a pre-approval A pre-approval will tell you how much a lender is likely to loan you and at what rate of interest. The best thing you can do here is work with a mortgage broker who will send your pre-approval application to multiple lenders at once. You could do this on your own, going from one lender to the next, but it will count as multiple hits to your credit. Whereas a mortgage broker’s submission counts as only one hit to your credit.
- Think outside the box Many home buyers only think of getting a mortgage with one lender: the one they already have accounts or other products with. It’s smarter to look into all your lending options. Big banks, small banks, credit unions, mortgage companies and so on. Do the research and find the best offer. A mortgage broker can help you with this.
The 5 C’s of credit, Character, Capacity, Capital, Collateral and Conditions come together to another C: Confidence. Confidence from your lender that you’ll be able to pay your mortgage and confidence in yourself that you’ve chosen the best option for your circumstances.
To get started with a mortgage broker contact us today!