Question: Should you get your mortgage pre-approved before you shop for a home? Answer: Definitely! Here’s 6 good reasons why.
1. Save Time
Shopping for a home is exciting! However, it can be disappointing if you find a home you love only to find out that you don’t qualify for the mortgage. Make sure you do your homework first. Having your mortgage pre-approved gives you a level of comfort that the home you buy is within the right price range. There’s no sense in wasting your time (and your realtor’s) shopping for a home you can’t afford. It’s best to know you will qualify for a mortgage once you make an offer to purchase.
Once you find a house, having a pre-approval will speed up the final mortgage approval. When you make an offer on a home it comes with a “Conditions Removal” date. Having financing in place is one of those conditions. If you’re scrambling to get financing in place and can’t meet the date, you’ll need to get an extension. This means going back and forth between your realtor, the seller’s realtor, and the seller. Not only does this take more time, you could lose out on the home purchase if the seller doesn’t agree to the extension.
2. Plan your budget
For first time home buyers, getting a pre-approval is an opportunity to have a good discussion with a mortgage lender about what is required to get approved for a mortgage. You will learn how much money you’ll need for a down payment, the amount required for closing costs, and have an opportunity to review the various rates and terms available. And of course, determine how much of a payment you can afford. It’s basically laying the groundwork for your final mortgage approval once you actually make the purchase.
There are other monthly costs to consider aside from the payment. House insurance, utilities, taxes etc. The pre-approval stage is a good time to look at all the costs and get a realistic budget figured out. There’s more about costs and budgeting in this article.
3. You’ll Make Better Decisions
There are a lot of steps to a home purchase and many decisions to be made. When you get your mortgage pre-approved you can make many of the financing decisions in advance. This gives you time to do some research and make informed choices. Here are some of the decisons you’ll need to make:
- How much money will you use for a down payment? How will this impact the cost of mortgage insurance?
- What steps do you need to take to access your down payment funds? This is important if you are using RRSP Home buyers plan or have self-directed investments.
- How much of a payment can you afford?
- Do you want to make payments weekly, bi-weekly, semi-monthly, or monthly?
- What other costs will you have? Renovations? Appliances? Window coverings?
- How long do you want to lock in your rate for? This is your mortgage Term.
- Are prepayment options important to you? More on this below.
- Do you need mortgage life insurance or payment insurance? How much?
- Which lawyer will you use?
4. Reduced Stress
From my experience as a long time banker, I can say with certainty that the most stressful banking transaction for customers is home financing. Having a pre-approved mortgage eliminates so much of this stress.
Let’s face it, planning ahead for anything reduces stress considerably. If you look at the questions above you can see these aren’t small decisions. When you make an offer on a house, the clock starts ticking for getting financing in place. If you’re not prepared, you’ll feel pressured into making quick decisions. Or worse, your house purchase can fall through because you can’t meet the financing condition on time.
There is no cost or commitment when you get a pre-approved mortgage. So wouldn’t you rather have the answers to the above questions figured out ahead of time? I guarantee you’ll enjoy house hunting a lot more if you do.
5. Interest Rate Guarantee
This is an important, often overlooked, and misunderstood part of a mortgage pre-approval. Understanding and managing rate guarantees saves you money when interest rates are increasing.
When you apply for a pre-approved mortgage you choose a mortgage rate and term. Your mortgage approval has a rate guarantee for that specific rate and term. At anytime before you purchase a home and finalize your mortgage financing you can change your mind on the rate and term and that will generate a new rate guarantee. If interest rates are stable or declining rate guarantees aren’t too important. When interest rates are increasing, then a good rate guarantee is a Big Deal.
Banks/brokers offer different rate guarantee periods from 30 days up to 130 days. A long rate guarantee can be really beneficial in times of rising interest rates.
Rate Guarantee Example
It’s July 1st and you are applying for a pre-approved mortgage. The 5 year fixed rate is 2.80% and the 3 year fixed rate is 2.90%. You decide that you don’t want to lock in your mortgage for too long and you choose a 3 year rate at 2.90%. Your lender offers a 90 day rate guarantee so you’re provided with a pre-approval confirmation with a rate guarantee period to October 1st. This means you are guaranteed this interest rate as long as you purchase your home and your mortgage is in place no later than October 1st.
Now it’s August 1st and you haven’t bought a home yet. You’ve heard that interest rates are increasing so you think maybe locking in for a 5 year term might be a better option. If, as of August 1st the 5 year fixed rate is now 3.0%, that’s the new rate you will get, not 2.80% that it was on the day you first applied. The rate guarantee you were given on July 1st was only valid for the 3 year term at 2.90%. If rates have gone down, then no worries, you will get the lower rate.
Be aware that your mortgage has to be in place before the end of the guarantee period. If you purchase your home on September 15th and you don’t take possession until October 15th, your rate guarantee may no longer be valid because it expired on October 1st.
Managing Rate Guarantees
You can update your rate guarantee at anytime. Let’s say you have a Pre-Approved Mortgage in place and a month has gone by and you haven’t found a home yet. You should contact your mortgage lender to see if interest rates have changed. If the rate is the same or lower, ask them to reset your rate guarantee period. What’s the benefit of doing this? You initially had a 90 day rate guarantee starting on July 1st, now you will have the rate guaranteed for a further 90 days from the day they reset it. There is no downside because if rates go down by the time you buy your home you will always get the lower rate and you will have protected yourself from a rate increase for the next 90 days.
6. You’ll Save Money
Many of the points above come down to one of the most significant advantages of getting a pre-approved mortgage. When you have the time to shop around, you save money. When you’re not making rushed, uniformed decisions, you save money. The decision of how much of a down payment to make is significant. Mortgage insurance fees are substantial, the less money down, the higher the fees. The higher the fees, the higher your mortgage amount and therefore, higher interest costs.
Saving .25% interest by shopping around for the best rate saves thousands of dollars. A good rate guarantee in times of rising interest rates can mean a rate .25% or .50% lower. Try out this calculator to see the impact on your cost of interest when you reduce the rate by .25% or .50%. There’s more information about shopping for the best rate below.
Mortgage life and disability insurance is costly. Taking the time to shop around and get the appropriate coverage at the best price. Here’s more information about mortgage insurance to help you make this decision.
Those are the main benefits of getting a pre-approved mortgage. Read on for a guide to getting an approval, mortgage rates and terms, and shopping for interest rates.
How do I Get a Pre-Approved Mortgage?
For your first home purchase and mortgage it’s best to set up an appointment to meet with a mortgage lender in person. There are other options like applying online or by phone, and you can start the process this way if you choose. But this is such a significant purchase that it’s well worth it to take the time and meet with someone. Many of the banks have mobile mortgage specialists that can meet with you in the evenings and weekends at a convenient location so it’s easy to set up a meeting. Video conference is an option if you prefer not to meet in person.
Prior to your appointment, call or email the mortgage lender to find out exactly what documentation you need to bring to the appointment. Be prepared by having income confirmation, confirmation of any assets such as investment statements, and bank account statements. Ask the lender to send you a list of what to bring.
Detailed Income verification is a big part of getting any type of financing approved. The required documentation varies depending on how you earn your income. If you have a stable job and receive a salaried income that is consistent every month then you’ll just need to provide 2 recent paystubs and your last year’s T4 or tax return.
Examples Documents for Income Verification
- If less than six months on the job you need a letter from your employer stating that you’re not on probation.
- Currently on a leave of absence? Then you will need a letter from your employer confirming when you are returning to work.
- If you are self-employed, or have seasonal income, then you’ll need to dig up 2 to 3 years tax returns. Your income will be based on an average of the past 2 years.
- If you own a limited company then you’re going to have to provide financial statements from the company as well.
- Additional forms of income like overtime or bonuses will not be included as income unless you can prove that it’s consistent over the past 2-3 years. You’ll need tax returns to support this.
- Employment Insurance will only be considered as income when you are a seasonal employee. You’ll need tax returns to show you’ve had a steady employer and a 2-3 year history of the combined income/EI payments.
Also, if 4-5 months have passed since your approval and there have been any significant changes in your finances you will need to re qualify. Let’s say you started a new job or financed a vehicle since your pre-approval – that could change whether you still quality.
Again, it’s best to confirm in advance exactly what you need and gather this all before your appointment. The lender will not be able to proceed with your application without it.
Approving your Application
Once you’ve provided your mortgage lender with all the necessary information, they complete an application and have you consent to a credit bureau. You need to meet certain criteria to be approved such as a good credit score, Total Debt Service and Gross Debt Service requirements, and evidence of a sufficient down payment.
Upon approval of your application, the lender provides you with a pre-approved mortgage confirmation. This confirms the amount of the mortgage you are approved for, the term, interest rate, and any conditions of the mortgage approval. The confirmation will also state when your interest rate guarantee expires. Make sure you get this in writing, not just a verbal confirmation.
Choosing a Mortgage Term and Rate
What do you need to consider when choosing a mortgage term? A good interest rate is a top priority. You are borrowing a large amount over a long period of time therefore the interest cost is significant. Do some research ahead of time to see what interest rates are being offered in the market place. Once you have an idea of current rates, think about how long of a term you want to fix or “lock in” your mortgage for. Often, banks offer the best rates on a 5 year fixed-closed mortgage so that you will keep your mortgage with them for 5 years. If you switch to a different bank or refinance your mortgage before the 5 year term is up you will pay a sizable interest penalty. When interest rates are on the rise, the best rate may be in a shorter term, like 3 years.
The lowest rate isn’t always the right answer. Locking in a rate for a longer time period gives you peace of mind. It can be comforting to know your rate and mortgage payments will not change in the next 5 years. What if a 2 or 3 year rate is lower? No one has a crystal ball to see the future so you have to weigh the benefit of having a lower rate now with the possibility that when you renew your mortgage in 2-3 years the rate could be higher. Will you be able to afford a higher payment if that happens? Or it could be lower and you’ll save even more money.
You also don’t want to lock in your mortgage for a long term if you are planning on selling the home in a few years because you’ll have to pay penalty to pay it off early. There are options to “port” your mortgage to a different house if you buy a new one, but there are a number of rules around this.
There are also options for variable rate mortgages. With variable rates, the interest rate changes based on the Prime lending rate determined by the Bank of Canada. While a variable rate mortgage is usually a low, attractive rate offer it’s not for everyone. An increase in interest rates means you will end up with a higher rate and payment. A cushion in your budget to allow for payment increases is a good idea If you choose this option. And you’ll also want to be on top of any changes in interest rates so you can make a decision to lock in your rate if interest rates start increasing rapidly. Avoid the variable rate mortgage if you like stability and get anxious about rate fluctuations.
Should you Shop Around for the Best Rate?
You absolutely want to shop around for a good interest rate. Other factors to keep in mind are getting quality service from your mortgage provider and a long rate guarantee period. The rate guarantee holds the rate in place if it takes a few months to find a home.
I recommend looking online first to get an idea of various rates and terms in the marketplace. A site like rate hub is a good resource. Then choose a mortgage lender and have a meeting in person to get your mortgage pre-approved. If you’re not satisfied with the rate or service from your lender, apply to a few more places by phone or online. It’s a pretty competitive market so most of the big bank’s rates will be similar, or they will match another banks offer. So if you like your local BMO branch but you see online that the RBC has a better 5 year rate, ask BMO to match the rate offer. Banks typically match rates of other major banks to keep you as a customer.
It’s a great idea to get a few pre-approvals in place, just don’t go overboard shopping around. Each time you complete an application with a different bank it generates an inquiry on your credit bureau. Numerous inquiries within a short period of time lower your credit score. And it is time consuming and confusing to apply at too many places.
Check for Work Perks
Banks have programs set up with different companies and industries. For example, RBC has preferred mortgage rates for medical professionals, BMO has preferred rates for RCMP, TD for select Alumni, to name a few. So preferred rates are out there, but you need to ask. Check around in your workplace first and then check with your mortgage lender.
Along with a good interest rate and rate guarantee period, certain features of the mortgage may be important to you. Do you want the option to pay off your mortgage quickly? If you plan to make extra lump sum payments on your mortgage, or want the option to increase your payments each year then make sure you review the pre-payment options. There are some mortgages that have attractive rates but have a lot of restrictions to pay the mortgage early. For example, when you see terms like 20/20 it means that you can:
1) pay an extra 20% down on your mortgage each year with no penalty and
2) increase your payments by up to 20% each year.
Without this option, you would pay a penalty if you tried to pay extra on your mortgage during the selected term.
For fixed/closed mortgages, you can pay down a lump sum of any amount when your term comes up, without any penalty.
Now that you have a confirmation for your Pre-Approved mortgage, find yourself a good realtor and the fun part begins. House Shopping! What happens once you find a home you like? Read Steps for Getting a Mortgage to be prepared for the next steps.
A Few Things to Note
A pre-approved mortgage does NOT 100% guarantee that you will get a mortgage for your house purchase. The mortgage will be subject to approval of the property that you buy. You will not receive a final approval until you make an offer to purchase and a property appraisal is completed.
I welcome your comments and questions, and please share this if you have found the information helpful.