By getting your mortgage preapproved, you’ll know how much you can borrow to buy a home, as well as the interest rate on the loan. What are the advantages and risks of a preapproval? How do financial institutions decide whether to preapprove a mortgage? How can you increase your chances of getting preapproved?
Advantages and risks
A mortgage preapproval means a financial institution is telling you the loan amount you can qualify for and at what interest rate.
Applying for a mortgage preapproval is optional when buying a home. The process is free, and you don’t have to commit to anything. However, there are some benefits and risks you should consider.
What are the benefits? When a financial institution preapproves your mortgage, the loan and interest rate are guaranteed for a few weeks or a few months.
Mortgage preapprovals involve an in-depth analysis of your financial situation by the financial institution. This is reassuring to a seller because you’re demonstrating you can get a loan and are serious about buying. This is an advantage over so-called mortgage pre-qualifications, which are based only on information you provide to the financial institution. A prequalification is less formal and detailed than a preapproval, but still gives you an idea of how much you might be able to borrow.
Sometimes it’s better to wait until your financial situation improves before applying for a mortgage preapproval. A preapproval depends on a strong credit report, a reasonable debt service ratio (comparison of your income versus your debts) and the size of your down payment. There are risks if you apply for preapproval and your financial situation isn’t very stable. For example, you might end up with a high interest rate. If your application is refused, this could have a negative impact on your credit report.
Strong credit report
Financial institutions carefully consider your credit report before preapproving your mortgage. You can get a copy of your report by contacting a credit agency like Équifax or TransUnion, but this is optional.
Your credit report shows your credit score, which is a number between 300 and 900. If your score is under 680, it will be much more difficult to get a mortgage preapproval.
It’s worth noting that your credit score changes over time. If you want to maintain or improve it, there are certain things you can do, like paying all your bills on time. The better your payment history, the higher your chances of having a good credit score.
However, your credit report might contain some mistakes. For example, if you’re the victim of identity theft, you could end up with a lower credit score if the person who stole your information got loans in your name without making any payments. To avoid unpleasant situations like this, it’s a good idea to consult your credit report on a regular basis and request any necessary corrections.
For more information, see our article Credit Reports.
Reasonable debt service ratio
Financial institutions check whether you have a reasonable debt service ratio. In other words, they calculate whether you’ll be able to pay your expenses after you buy the property, as you did before. You’ll have a better chance of getting preapproved if your financial institution believes you can meet your mortgage payments without falling behind on your other payments.
If you have a lot of debts, you might want to consult a professional to help get your finances in order.
To learn more about calculating debt service ratios, click on the drop-down menu below.
Financial institutions usually make sure that your future expenses for the home are below 35% of your gross income (that is, your income before deductions at source such as income tax). Financial institutions calculate this percentage using this formula:
monthly payments (main part of loan and interest)
+ property taxes (municipal and school taxes)
+ heating costs
+ 50% of condo fees (if applicable)
gross monthly income (before deductions at source)
The result of this calculation, called the “gross debt service ratio” (GDS) must be under 35.
Financial institutions also check whether your recurring monthly expenses after you buy the property will be less than 42% of your gross income, according to this formula:
GDS (see above)
+ all current monthly expenses
gross monthly income (before deductions at source)
The result of this calculation, called the “total debt service ratio” (TDS), must be less than 42.
Good down payment
A down payment is the amount of money you must pay when buying a home. Your mortgage only covers the difference between your down payment and the purchase price.
Your down payment must usually be higher than 5% of the purchase price (possibly more depending on your situation). Your financial institution might not preapprove your mortgage if your down payment is too small.
For more information, refer to our article on down payments.
Gather your documents
The preapproval process might go faster if you have all your documents ready for your first appointment with your financial institution. This is what you’ll need:
- proof of identification
- proof of income (for example, a recent pay stub or a notice of assessment)
- information about your assets (what you own) and your debts
Be honest. If you provide false information, you might end up with payments that are too high to manage. Also, if you make false statements and the financial institution finds out, they could consider you in “default” and exercise their rights as a mortgage creditor, such as seizing and selling your house.