Mortgage Pre-Approval: How to Improve Your Credit Score

Are you interested in learning about the mortgage pre-approval process? Or, do you want to learn how to improve your credit score? One of the biggest steps you’ll take in life is buying a home. And, while you might want to go and pick out your dream home first, this is a mistake. You need to get pre-approved first so you’ll know how much money a lender (bank) will give to you. You’ll also need a good credit score to lock in the best interest rates. But, if your credit score is low, don’t worry. There are several ways to improve it.

Here’s how to increase your credit score and get pre-approved for your dream home (so you can go pack!).

Steps for Mortgage Pre-Approval

Often, when people shop for their first home, they hop online and check out the real estate websites. Or, they drive through their favorite neighbourhoods and pick out a place. They might even stop in at an open house and take the tour. While it’s exciting to search for a home with the gorgeous landscaping or the huge master suite, that's actually Step 3 in the homeownership search.

Here’s the order you should follow when looking for a new home:

Step 1

Get pre-approved by a bank. This lets you know “how much” house you can afford. A mortgage lender will look at your income, credit score and debt-to-income ratio.

• If you have good credit: The mortgage lender will give you the potential mortgage amount you can apply for. This is a qualification letter. For example, they might say you you have good credit and immediately approve you for up to $800,000. Great! You can now jump toStep 3 and start looking for a home. Back to the open houses.
• If you don’t have good credit: The mortgage lender might recommend that you take a few months to a year to pay down debts and raise your credit score. This means you can benefit from Step 2 and then go to Step 3. Doing so will help you lock in a better interest rate for your mortgage loan. And, you’ll pay less on your mortgage.

Step 2

Improve your credit score. If you have poor credit, there are steps to take to improve your score:

• For certain debts under seven-years-old, you can pay these off by negotiating cheap payoff terms with your existing creditors.
• For certain debts over seven-years-old, you can have these removed from your credit report. See Step 2 below for more information.
• You can save more money towards your down payment. This will lower your mortgage loan amount.

The process can take a few months to a year, so give yourself time. Once you re-approach the bank, they can perform another credit check and you can move to the next step.

Step 3

At this step, you've cleaned up your credit and your mortgage lender was impressed with your credit score. You can now start looking for your new home (almost time to celebrate!). And, you have your loan qualification letter in hand stating the amount you're qualified for. This isn’t required when searching for a new home but it has several advantages:

• It lets sellers know you’re serious about purchasing their home: Let’s say there are two couples looking at a house. One is qualified with a bank letter, the other is not. The sellers might choose the pre-qualified because they're ready. The other couple might not even be able to afford the home.
• It’s leverage if you get into a bidding war: Some homes for sale will attract several buyers and a bidding war can start. Let’s say the bank approves you for $800,000. You find a home that’s $700,000 but another buyer offers $735,000. You can go higher and make another offer because your threshold is $800,000.

Let’s now take a look at each step in-depth so you can get one step closer to your dream home (and all those amenities you want it to have).

Step 1: The Mortgage Pre-Approval Process

The mortgage pre-approval process is when a mortgage lender looks at your credit, debts and income. They then determine the maximum amount of money a bank will lend you. You can also find out what your potential interest rate will be based on your credit score.

Your pre-approval amount is only an estimate. It doesn’t guarantee that you will get a mortgage loan. The actual mortgage approval depends on how much money you put down on a home. But, there are still benefits.

When you’re pre-approved, you can:

• Learn the mortgage loan amount you qualify for or “how much” house you can afford.
• Estimate how much your potential mortgage payments and other costs will come out to.
• Lock in your potential interest rate for 60 to 120 days or in some cases 160 days (varies by lender).
• Get a pre-approval letter from the bank for leverage when shopping for a new home.
• Shop with more confidence because you're now ready to make an offer!

"How Much" House You Can Get for Your Money

Another factor in the pre-approval and home ownership process is the value of the home you want to purchase. If you're shopping in an area like Toronto, Montreal, Victoria or Vancouver, you might not get "a lot of house" for your money as real estate is so expensive. But, a good recommendation is to expand your home search.

By shopping in other areas you might get "more house" for the same money. What you find might not be your dream home. But, it can help you build equity until you're ready for a bigger purchase. An affordable home in another area can also give you more options. You can select from several homes and include amenities important to you (the deck, jacuzzi, bigger garage, pool). Now we're talking!

Look at several properties in different areas and include some in lower price ranges. This helps to ensure you don’t stretch your budget too thinly and become house rich and cash poor. Why does this matter? You have other costs.

Additional Costs to Consider

Aside from your mortgage payment you have other costs. In addition to your down payment and monthly mortgage costs, you’ll also have:

Closing Costs

There are several fees that you might incur with your closing.

These can include:

• The loan origination fee and any discount points.
• The appraisal fee, your title search and title insurance.
• Any surveys, the taxes and deed-recording fees.
• Charges for running your credit report and any fees to your real estate attorney and realtor.

Moving Costs and Home Insurance

You'll obviously need to hire movers but you'll also have to set up home insurance. If you were renting, you probably had tenant insurance. Or, if you had a condo, you had condo insurance. But, when you buy a home, you'll start a new home insurance policy. To save costs here, use a home insurance comparison tool to lock in the most affordable rates.

Costs if You Temporarily Carry Two Mortgages or Mortgage and Rent

A problem some potential homeowners find is incurring costs in transferring from one home to the next. This can sometimes be a big hurdle for potential home buyers:

• If you rent: Your landlord may or may not let you break your lease early. If the landlord doesn't, you might be paying rent and a mortgage payment until your lease ends. The other option is to look for a new home around the time your lease will end. But, what if you don't close in time? Or, what if you don't find the home you want or get approved?
• If you own an existing property like a condo: Let's say you own a condo and move into a single-family home. You don’t know how long it will take to find a buyer. You might find yourself juggling two mortgages. And, you might have to come down on your asking price for your condo to expedite the closing there. That way you avoid two mortgage payments.

Other Associated Costs

There are other costs associated with your new mortgage. These include:

• If you move into a housing development with amenities, there might be a monthly maintenance charge. Some developments offer a clubhouse, pool, gym, garage and landscaping services. But, you might have to pay monthly maintenance costs for these.
• You might have a monthly or annual tax bill to pay on the home if it's a single- or multi-family residence.

Checking Your Credit Report

When the bank first looks at your credit, this lets them know if you’re ready for a mortgage. Don’t get discouraged if your credit score isn’t high. You might have errors that can be removed or you might have small debts you can pay off. These improvements can raise your score (see the credit section below).

In some cases, when the bank looks at your credit report, they might:

• Refuse to pre-approve you for a mortgage until you improve your credit score.
• Offer to approve you for a smaller loan amount. Or, a higher mortgage interest rate.
• Only approve you if you make a large down payment for your mortgage.
• Request that you have a cosigner.

Paperwork Your Mortgage Lender (Bank) Will Need for Your Pre-Approval

To start the pre-approval process, a mortgage lender will request specific paperwork from you. They need to see your assets and what you own. They will also look at your revolving credit accounts and other debts. And, they want to see how much savings you have and your employment information.

You’ll need to provide the bank with:

• A copy of your identification and a letter from your job. The bank might request your hourly or annual salary, your position at your job and length of employment. They may ask also for pay stubs.
• Your bank statements or registered retirement savings plan (RRSP) statements. They need to confirm you can pay your closing costs and down payment. If you’re self-employed, you need to provide a notice of assessment (2-years worth). This is from the Canada Revenue Agency.
• Paperwork on any assets you have (another property, boat, car).
• All credit card balances and limits (including any store or gas credit cards). Any other debts like car payments or leases. You should also include any alimony or spousal support. Other debts might include school loans, lines of credit or outstanding tax obligations.

Helpful Pre-Approval Questions to Ask the Bank

When you're requesting a pre-approval, there are a host of questions you should ask your mortgage lender about.

Pre-Approval Questions 

These include:

• How long is the pre-approval good for?
• Can you extend the pre-approval if you need more time?
• Are you automatically qualified for a lower interest rate if rates suddenly drop during the time you’re pre-approved?

Mortgage Product Questions

These include:

• The rate hold: Will you lock in your rate for 60, 120 or 160 days?
• The down payment: Will it be 5 percent, 10 percent or 20 percent?
• The products: Will you have a fixed rate ranging from 1to 10 years or a variable rate at 3 to 5 years?

Qualifying for Your Mortgage

When your broker or lender qualifies you, there are a lot of calculations they will tally to determine how much house you can afford. There are two ways to determine how much you might qualify for:

• Get an official qualification: Let the mortgage lender total your debt load and monthly housing expenses. They will look at your income, all expenses and how much you want to borrow. They’ll also factor in your debts, credit score and the amortization period.
• Get an unofficial qualification: You can use a mortgage affordability calculator. This is a convenient and helpful way to know how much house you can afford. You can try it now. Whether you’ve started the pre-approval process or not, it’s recommended. It can give you a ball-park estimate for your own records.

Monthly Housing Cost Totals

The total you spend on your monthly housing costs should not be greater than thirty-two percent of your gross income. This is your gross debt service (GDS) ratio.

It includes your:

• Monthly mortgage payments and any property tax you pay.
• What you pay to heat your home.
• About fifty percent of any condo fees (if it applies).

Your Debt Load Totals

The total amount of debt (housing costs, other debts) should not be more than forty percent of your income (gross). This is your total debt service (TDS) ratio.

In addition to your housing costs, it includes debts such as:

• Credit cards and lines of credit.
• Car insurance, car payments and tax debts.
• Student loans, child support and any spousal support.
• Life insurance, medical insurance costs, utilities and any other debts or bills.

The Mortgage Stress Test (But, Don’t Stress. It Helps You.)

When you hear stress test, you might think, “Uh, oh.” But, the mortgage stress test is helpful. It lets the bank know if you can afford your mortgage payments if a rate change occurs. Federally regulated lenders aren’t required to use this test.

If your lender states you will need mortgage loan insurance, they will use the higher interest rate from:

• Bank of Canada’s five-year mortgage rate for conventional loans. Or,
• The rate you set up with your mortgage lender.

If your lender states you will not need mortgage loan insurance, they will use the higher interest rate from:

• Bank of Canada’s five-year mortgage rate for conventional loans. Or,
• The rate you set up with your mortgage lender plus an additional two percent.

Let’s look at an example...

You’re applying for a mortgage with five percent down. You have to take out mortgage loan insurance because you’re putting down less than twenty percent. And, let’s say your interest rate is three percent while the Bank of Canada’s rate is five percent. You have to qualify at a higher rate even though you’re going with the lower rate.

Calculating Your GDS and TDS Ratios

When the bank calculates your totals, they might overestimate the costs. But, there are a lot of costs with having a mortgage. These can include closing costs, mortgage loan insurance, moving costs and any repairs. There also might be maintenance costs and any unexpected expenses. To help you, use a mortgage affordability calculator. This can help you see if you qualify for the mortgage amount you want.

When you compare the results:

• If your total costs are lower than the maximum amount calculated, you can probably afford that mortgage amount.
• If the total costs are higher, your DSR is too much and you might want to look at a cheaper home, save a bigger down payment or lower your debts.

Step 2: Improving Your Credit Score

Your credit score includes a lot of important factors like your payment history, types of credit accounts and total debts. When the banks run your credit report they want to see how consistent you pay bills. And importantly, how responsible you are with debts. But, let’s say you had a temporary job loss. This doesn’t always work against you. You can explain to your lender if special circumstances caused you to briefly fall behind on payments.

What is a Good Credit Score?

Credit scores can range from 301 and go up to 850. In that range, there are different categories lenders use for determining creditworthiness.

These include:

• Excellent credit can range from 781 up to 850.
• Good credit can range from 661 up to 780.
• Fair credit can range from 601 up to 660.
• Poor credit can range from 501 up to 600.
• Bad credit is anything below 500.

Ways to Improve Your Credit Score

Having credit is a big responsibility because it’s a form of debt. There are a few steps to help you raise your score.

These include:

With Your Bill Payments

• Always pay your bills and credit card payments on time. And, make at least the minimum payments every month. With credit cards, try to pay off the full balance each month so you don't have to pay interest.
• If special circumstances arise like an illness or job loss, contact your credit card company or another credit-issuing bank. They might be able to waive late fees and hold payments for a set period of time until you’re financially reestablished. Some credit card companies offer insurance against a job loss or illness.
• Never skip a payment even when you’re disputing a charge.

With Your Credit Accounts

• Keep a variety of credit types (auto, mortgage, credit cards, student loans).
• Try to only use only less than thirty-five percent of the credit you have available. As an example, if you have $10,000 available on one card and $5,000 on another, your credit limit total is $15,000. You don’t want to borrow or have used up more than $5,250 which is thirty-five percent. It can adversely affect how lenders issue credit to you even if you make payments on time.
• Keep credit card accounts open even if you have no balance. If they show a good payment history, this is favorable with lenders. And, if you ever file for bankruptcy, open a secured credit card to rebuild your credit.

With Your Credit Report

• Consider taking out a personal loan to pay off your credit cards. You can improve your revolving credit (credit cards). And, your loan is an installment debt so it will have a lower interest rate.
• Run your credit report once a year and report any suspicious transactions you find on your credit report. Request to remove any bill you see that's seven years old or older. These can automatically be removed. This applies to old medical debts and credit card balances. Dispute the charge with the appropriate credit bureau. And, state that the account has been open longer than seven years and can come off your report.
• With more recent debts, contact the collection agencies for the companies to negotiate a payoff. You might be able to pay less if you state you'll pay the same day so call once you've set aside money and you're ready to negotiate. Ask the collection agency to give you the total amount in writing stating your balance will be paid off.

Work on paying down your debts for six months to a year. Then when you reach out to a lender to request a pre-approval, let them run your credit (so you're not doing it twice). They'll recommend how much your score has come up and if you can now get pre-approved or need to continue paying down debts.

Controlling the Credit Checks on Your Report

There are different types of credit checks:

A hard hit is if an employer or mortgage lender looks at your credit. Or, if you apply for a credit card. These are viewable by anyone who looks at your credit.

A soft hit is when you pull your report or a business pulls it to update your record.

To keep your inquiries from damaging your credit:

• Limit how often you apply for credit. Don’t keep applying as this can bring your score down. Repeated credit checks can look like you urgently need money or you’re living beyond your means.
• Only get quotes from lenders (mortgage, car loans) over a short period like a week or two.
• Only open credit cards and lines of credit if you need to. For example, you might want to open a home equity line of credit (HELOC) loan to make upgrades or repairs to your new home.

Step 3: Looking for Your Home and Finding Your Mortgage

Now that you've cleaned up your credit and gotten your pre-approval, you're ready to shop for your new home. Take your time in shopping and remember to widen your search area. When you find a home that you're interested in, talk to a realtor that represents buyers. The agent showing the home might be a seller's agent meaning they'll represent the seller's interests, not yours.

Helpful Mortgage Questions to Ask the Bank

Once you find a home you want to purchase, there are a host of questions you should ask your mortgage lender about when you're preparing to make an offer.

Mortgage Questions

These include:

• Asking about the interest rate, amortization period and term.
• You'll also want to ask about potential payments, prepayment options and how to save on interest. You can use a mortgage payment calculator to give you an idea of what your monthly mortgage payments come out to.
• Ask about the fees you'll have to pay with your mortgage and mortgage insurance.
• Ask if there are penalties if you sell the home before the term ends or options if you pay it off early.
• If applicable, ask about transferring a mortgage balance if you buy a new property. And, how to register your mortgage with a collateral or standard charge.

Where to Find Your Mortgage

When you’re ready to find a mortgage loan, shop around. Mortgage lenders and brokers vary in the packages and interest rates they offer. There are several sources for financing your mortgage.

These include:

• Mortgage lenders like banks, mortgage or insurance companies and trust or loan companies. You can also try through credit unions or caisses populaires (for Quebec residents).
• Mortgage brokers who find a mortgage lender for you. They may not have access to the same lenders so shop around. They don’t charge fees but receive commissions per transaction. Always confirm your broker through your province or territory’s regulator.
• A mortgage comparison tool is another way to find a lender. You can conveniently view the best rates from lenders all over Canada.

Preparing For Your New Home

After securing your mortgage terms and having the inspection and closing, it's time to move in (and celebrate).

You need to contact:

• The moving company to negotiate a price for your move.
• A home insurance company. Use an online insurance comparison tool to lock in the best rate.
• Your postal carrier to change your address and forward your mail.
• The alarm company, the utility companies and schools in the area if you have children.

Are You Ready to Get Pre-Approved and Find Your New Home?

Improving your credit and getting pre-approved can be a time-consuming process. But, you'll save time. Get pre-approved first so you'll know how much house you can afford. If the bank says you need to improve your credit first, take six months to a year and pay down your debts. You can always take out a personal loan with a smaller interest rate. Once you're ready to shop for homes, widen your search so you can get "more house" for your money. When you're ready to shop for your mortgage rates or home insurance, contact RATESDOTCA.

With RATESDOTCA, you can compare the lowest mortgage rates from Canada's best lenders.