Mortgages 101: A Guide to Getting Your Mortgage
You’re probably already familiar with what a mortgage is: a loan to buy real estate. However, there’s a lot more to know than just that.
In this article, we’ll explore mortgages in-depth. We’ll go over what a mortgage is, how the mortgage process works, where you can get a mortgage and important terms to know.
What is a Mortgage?
A mortgage is a loan type that can be used to purchase a home. The property acts as security for the loan. A mortgage tends to be for a large sum and is usually paid off over 25 or 30 years.
When you sign up for a mortgage, you’re agreeing to make regular payments. These mortgage payments are comprised of both principal and interest. When a payment is made, it’s first used to cover the interest, then the principal. A mortgage lets the mortgage lender take possession of the property should you fail to make the agreed-upon payments on time.
The Mortgage Process
Once you’ve decided you’d like to buy a home, the next step is to figure out how to pay for it. Unfortunately, most of us don’t have the cash saved up to buy a home outright. That’s where a mortgage comes in handy.
Before searching for a property, it’s a good idea to get pre-approved for a mortgage. When you’re pre-approved, you’ll know exactly how much you can afford to spend on a home. You also reduce your risk since you’re a lot less likely to make an offer on a home you can’t afford. (I’ll talk about the pre-approval process in greater detail later on.)
Once you’re pre-approved, you can go shopping for a home. It’s helpful to make a list of needs and wants. That way you can objectively look at each home when deciding if it’s right for you.
Once you find a home you like, you’ll put in an offer. Once your offer is accepted, you’ll work with your banker or mortgage broker to get the mortgage approval. You’ll need to provide documents and information. The lender will then sign off on everything if they’re good and you can remove condition of financing from your offer (if applicable).
How Do You Know it’s Time?
When is a good time to buy a home and take out a mortgage? A good time is when you’re personally and financially ready. That means you have a steady job, you’re settled in your personal life and you’re committed to staying put in the same place for the next five or 10 years.
If that’s not the case, you might consider renting until you’re ready to buy.
When applying for a mortgage, the lender wants to make sure you can afford it on a monthly basis. The lender does this with two debt ratios: the Gross Debt Service (GDS) Ratio and the Total Debt Service (TDS) Ratio.
The GDS Ratio looks at the percentage of your gross monthly income needed to cover expenses related to the home: your mortgage payments, property taxes, heating and maintenance fees (if applicable). Most lenders are looking for a GDS Ratio below 39%.
The TDS Ratio is similar to the GDS Ratio. It looks at all the same things as the GDS Ratio, however, it also factors in any other debt that you might have. If it’s revolving debt, such as credit card debt or a line of credit, 3% of the outstanding balance is usually used for debt servicing purposes. If it’s an installment loan with a fixed payment (i.e., a car loan, car lease or personal loan), the payment is used for debt servicing purposes. Most lenders are looking for a TDS Ratio below 44%.
It should be noted that the mortgage payments used in these calculations are higher than you’re actually paying. That’s because the payments are calculated using the inflated stress test rate (currently at 5.19%).
While the GDS and TDS Ratios factor some important homeownership expenses, it’s important to also factor in any other big expenses you may have, such as childcare expenses.