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The Mortgage Application and Approval Process

The first stage of the mortgage lending process involves filling out the application, verifying the information on this application, and confirming the value of the property. The process of determining the risk of an application, and whether to approve it, is called underwriting.

The underwriter considers three primary components of each application. The task of underwriting is to determine the borrowers ability to repay the funds under the agreed upon terms, their willingness to repay, and the adequacy of the real property as security for the mortgage loan.

1. The current financial position of the applicant.

Net Worth

The applicants net worth is determined to decide their overall financial well being. Of particular concern is the verification of available net worth for the purpose of down payment. The accumulation of assets beyond liabilities can be used as a general test of the applicants personal finances and income management in prior years.

Gross Income

One of the most important components of the loan underwriting process is determining the borrower's gross income. The income of all borrowers and co-borrowers is included in the calculation. The income can be derived from several sources, but it must be supported by historical documentation and have a high likelihood of continuation in the future. The underwriter is concerned with the quantity of income earned in order to determine the maximum mortgage allowable, and also the durability of these earnings to insure that the borrower will be able to make their mortgage payments for the full term of the mortgage.

The following outlines the types of income that may qualify as well as the verifications required to confirm them:

Salary: Income derived from any kind of salary, whether monthly, weekly or hourly is acceptable. Two or three years employment history is usually required.

Commission and bonus: Commissions and bonuses may be qualifying income if it is an ongoing and persistent component of overall earnings. To verify this the underwriter will average the last two or three years of income shown on your income tax returns and the year-to-date earnings from the written verification of employment or pay stubs. The task if to determine if this income is likely to continue in the future, and at what levels given the employment type.

Self-employment income: Generally, the underwriter will average the income earned through self-employment for the last three years from the applicant's income tax returns and the year-to-date earnings from a profit and loss statement of the business. Self employment can take many different forms so the underwriter will require as much supporting evidence as possible to determine and verify qualifying income. In determining the current amount of qualifying income generated by self employment the underwriter will take into consideration the trends in your business or industry in an effort to forecast future prospects.

Other Income: Income earned from rental properties, interest, dividends, pensions, and social security can be used, as long as it can be verified and will persist long into the future. Some incomes are discounted, or do not qualify at all, for the purposes of mortgage loan application. One time gifts or windfalls are not income nor is occasional overtime or a single bonus from your employer if it is not likely to be received again. In general, unemployment benefits or other insurance's with a finite disbursement period are not considered.

Funds to Close:
When the proposed loan is being used to finance the purchase of a home, the lender will determine the source of funds for the down payment as well as closing costs. The mortgage lender is verifying that closing costs and down payment amounts are not also going to be borrowed and have been accumulated over time from the borrowers own resources.

The following are acceptable sources of funds for closing:

Funds on deposit: Money that has been on deposit for at least 60 days in checking or savings accounts at any depository institution or investment company is acceptable, so long as it can be verified on bank statements for the past two months.

Stocks, Bonds, Mutual Funds, etc.: Cash equivalent investments are acceptable forms of funds. They can be validated through statements from investment companies for the last two months.

Sale of existing property: Many times the source of funds for the down payment on a home comes from the equity in a property that will be sold. The sales price of the property being sold is indicated on the loan application and any existing loan is verified on the credit report or through a verification of previous mortgage. The contracts of purchase and sale must be submitted to the mortgage lender in order to verify that the proceeds of disposition are sufficient and closing dates are in order.

Gifts from family members: Gifts from family members for the down payment and/or closing costs are acceptable so long as there is no requirement for repayment. CMHC will require the execution of a gift letter as proof that the gift is bona fide.

CMHC requires the borrower to demonstrate their ability to cover closing costs in the amount of 1.5% of the value of the property. Closing costs can be equal to as high as 3% of the value of the property being purchased and can vary widely depending on the property being purchased, services required, taxes and insurance's applicable, whether the home is new or old, closing dates affecting interest adjustments, and the balances of any prepaid expenses.

Closing cost are typically one time fees that must be paid as a result of the purchase transaction. Other immediate costs are also incurred as a result of a home purchase. These include moving costs, costs to ready the home for your family, insurance coverage, lock smith and security costs, renovation costs, household affects such as drapes, appliances, and furnishings, and the installation of telephone - cable and internet access etc.

2. How Much Home Can You Afford

Once the lender has determined the applicants qualifying gross income and expenses they will calculate whether the applicant can afford the mortgage loan based on their ability to carry the shelter costs. Lenders use a ratios approach to determine this ability by setting maximum expenditure amounts.

Shelter costs include:

  • The Mortgage Payment
  • Property Taxes
  • Condominium Maintenance Fees
  • Heating Costs

While these are not the entire costs of home ownership, they are the most quantifiable ongoing expenses that will have to be paid.

Gross Debt Service Ratios (GDSR)

The GDSR is the ratio between gross income and shelter costs. The lender will set an upper limit on this ratio. As a general rule mortgage lenders will not allow you to spend more than 30% to 32% of your gross income on shelter costs. If the sum of the mortgage payment, property taxes, condo fees and heating costs exceeds the lenders stipulated Gross Debt Service Ratio, the mortgage will likely be declined, or a revised loan amount offered.

Assume the applicants monthly gross income is $5,000 and they are applying for a mortgage of $200,000 at an annual rate of 8% to be repaid over 25 years. The monthly mortgage payments would be $1,526. The lenders maximum GDSR is 32%.

The lender will add up the shelter costs related to the purchase of the subject property. In this case it is a single family dwelling with property taxes of $100 per month and $50 per month heating costs.

The Shelter Payments amount to 33.5% of the applicants gross income, higher than the maximum allowed by the lender. As such the lender will reduce the financing available to the applicant in line with the 32% GDSR maximum.

With Gross Income of $5,000 per month and a maximum GDSR of 32% the lender will only permit the applicant to have a maximum shelter payment of $1,600 (32% of $5,000)

By subtracting the property taxes of $100 and the Heating Costs of $50 we are left with the maximum gross income available for mortgage repayment. In this case $1,450. This is the applicants maximum mortgage payment.

The $200,000 mortgage the applicant has requested results in a mortgage payment of $1,526 at current interest rates of 8 %, exceeding the applicants maximum mortgage payment and pushing their GDSR above the limit.

The lender will calculate the maximum loan amount using the applicants maximum mortgage payment of $1,450. This results in a maximum mortgage of $189,986, given the current interest rate.

The applicant will have to provide a larger down payment in order to proceed with the purchase of the subject property. Given that their maximum mortgage is $10,014 less than they had anticipated they will have to provide these funds from savings or they will be forced to look for a more affordable home.

Total Debt Service Ratios (TDSR)

The TDSR is the ratio between the sum of both shelter and non shelter financial obligations combined, and gross income.
The lender is concerned with the applicants ability to carry costs other than simply the shelter payments. The maximum the applicant will be allowed to spend on both shelter and non shelter financial obligations combined is usually set at 40% to 42%. Total Debt Service Ratios above 42% result in payments that are likely to be unmanageable for the borrower in the long term.

Disregarding the applicants other financial obligations could mean approval of a loan to a borrower that has substantial non shelter financial obligations and may increase the risk of mortgage payment default.

Non Shelter Financial Obligations include:

  • Car Payments
  • Credit & Charge Card Payments
  • Personal Loans
  • Lines of Credit
  • Finance Company Loans
  • Long Term Leases (more than 1 year)
  • Tax loans
  • Long term RRSP catch up loans (more than 1 year)

Let's assume that the applicant agrees to a reduction of the mortgage amount to $189,986 in order to bring their GDSR within the allowable 32% limits. The next step is to determine if the borrowers other financial obligations are within the allowable Total Debt Service Ratio limits. Again the shelter costs are summed and any additional costs are also added. If these combined costs do not exceed the 42% maximum the borrower will be past the first step.

If the applicants GDSR is at the 32% maximum they will must not have more than 8% of their gross income committed to non shelter financial obligations, 42% in total.

How Personal Debts Can Affect Housing Affordability

If the applicants existing non shelter financial obligations are, say 18% of their gross income, the income available for shelter financing is squeezed and reduced to 24% of their gross income. 24% of the applicants $5,000 gross income results in a maximum shelter payment of $1,200. If we subtract the heating cost of $50 and the property tax costs of $100, the resulting maximum mortgage payment is now $1,050.

$1,050 will finance a mortgage in the amount of $137,576 at 8% per annum. This is substantially lower than the $189,986 the applicant would qualify for based solely on the GDSR. The applicants non shelter financial obligations are having a negative impact on housing affordability by reducing their available financing and consequently the applicants purchasing power.

In the graph below the applicant has credit card payments of 7% of gross income and car payments of 6% of gross income. The combined non shelter financial obligations of the applicant equals 18%.

After Taxes Ratios

The debt service ratio above may appear to leave a good deal of income for all other expenitures. However these ratios are based on gross income and not after tax income. A look at the applicants remaining income after taxes reveals a different picture.

The graph below displays a the maximum GDSR of 32%. After taxes these shelter costs constitute 49% of their disposable income.

The remaining 35% of after tax income does not leave the borrower with much room. In the case of our applicant with a gross income of $5,000 the remaining after tax income they will have is only $1,150 per month. These remaining funds must pay for all other expenses such as food, clothing, medical and dental, vehicle maintenance and operating costs, entertainment, personal property, and savings.

Gross Debt Service Ratios and Total Debt Service Ratios are the maximums set by mortgage lenders.

Purchasers may consider opting for longer mortgage terms in order to avoid the risk of rate increases. In addition, many purchasers are wisely advised to pay down their mortgage, particularly if a renewal at lower interest rates has resulted in a lower mortgage payment.

Set Your Own Debt Service Maximums

While these maximums set risk guidelines for mortgage lenders, the applicant should also calculate their own maximum GDSR and TDSR. In many cases the lenders maximums are too high for an applicant who wishes to have a little more spending money in their pocket each month. Applicants know their lifestyle priorities and spending habits far better than the mortgage lender. The maximum shelter costs a borrower can handle should be carefully determined by the family regardless of what the lenders maximums are.

3. Creditworthiness

Credit Analysis:

Another very important part of the underwriting process is determining the creditworthiness of the borrower. Loan underwriters review the borrower's credit report to find evidence of debt repayment behavior. Some of the important areas that are reviewed are:

Past and existing mortgage debt: The past repayment history on mortgage debt can be a good indication of a borrowers attitude toward mortgage obligations. A good payment history on mortgage debt is very important in the credit analysis.Generally, payments received 30 days past the due date are reflected in the credit report as late. Lenders vary in strictness, and some may not allow any late mortgage payments, while others will allow 1 or 2 in the last two years if there is a good explanation.

Installment and revolving credit: Other items on the credit report can also indicate a borrower's attitude toward their financial obligations. Credit reports indicate the outstanding balance, payment amount, and terms of payment on the borrower's revolving and installment debts. Underwriters review these credit obligations to determine the borrower's patterns of credit use and repayment behavior. Revolving credit refers to department store credit and bank credit cards. Installment credit refers to longer term credit with structured payment plans, such as car loans. Generally, underwriters are not concerned over isolated and minor slow payments indicated on the credit report. They look for an overall profile of the applicants attitude towards their financial obligations.

Collections, repossession, foreclosures and bankruptcies: Credit reports also indicate public records such as collections, repossessions, foreclosures, and bankruptcies. Though these items may indicate past credit problems, they sometimes have valid explanations. Underwriters may require a letter of explanation on items noted in the public records. Many times consumers have re-established credit and have an excellent payment history on their current obligations. It is important to forewarn the lender if there is an item on your credit report that requires explanation. Provide that explanation in detail so that the underwriter is comfortable with it.

Some lenders will approve applicants that have previously been bankrupt provided they have since re-established a good credit history and the cause of the bankruptcy was reasonably not the fault of poor credit management on the part of the bankrupt.
CMHC will, on a case by case basis, approve applicants that have been bankrupt provided two years has passed since they were discharged.

4. The Property

The home is the collateral for the mortgage loan. The lender must determine that the property offers adequate value as security in relation to the mortgage loan amount. In addition they must determine whether it is likely that there will be any capital or maintenance costs that would put a drain on the applicants financial resources and could affect their ability to manage their mortgage payment obligations in the future. In order to make this decision the underwriter hires a professional real estate appraiser. The appraiser will submit a report detailing their estimate of the value of the residence based on the recent sale of comparable properties in the area.

The underwriter will be particularly interested in the overall value of the property to ensure that it sufficiently covers the mortgage loan within the required loan to value ratio limits, usually 75%. The age and condition of the property determines its' remaining economic life. No mortgage amortization should exceed the economic life of the property. Properties in poor repair will likely cost more in maintenance or renovation in years to come. These costs are factored into the analysis.

Loan to Value Ratios (LVR)

The loan to value ratio is calculated by dividing the mortgage (s) by the property value or purchase price. This ratio sets another upper limit on the amount of financing a lender will provide to a qualified purchaser.

Mortgage lenders typically lend based on the borrowers ability to afford the costs associated with the property and financing. The amount of mortgage an applicant receives is determined by the borrowers debt service ratios and the value of the property. If the subject property has a lending value of $200,000 the maximum mortgage loan the lender will provide is usually 75% of this value, regardless of whether the applicant qualifies, from an income perspective, for a mortgage of $200,00. The lender will only approve a mortgage of $150,000 on this property unless the added risk of the high ratio loan is insured away by mortgage default insurance.

Mortgage lenders want to ensure that the applicant will have a sufficient stake in the property. In addition their equity contribution must be adequate enough to cover all costs and balances owed in the event that the lender has to take possession or sell the property. These costs can include legal proceedings, accrued interest, property repairs, insurance's, marketing expenses and Realtors fees as well as added administration costs. The equity also acts a safety buffer in the event that property values decline in a slower market.

Conventional Mortgage

Mortgages with a loan to value ratio of 75% or less are termed Conventional Mortgages. 75% is the maximum a lender can advance. If the applicant requires more financing they will have to purchase mortgage insurance

High Ratio Mortgage

High Ratio Mortgages have a LVR above 75%. The risk of these loans is substantially increased due to the lower amount of owner equity. Mortgage lenders will only allow an applicant to have a high ratio purchase mortgage if the applicant insures the mortgage through one of Canada's mortgage insurers, GE Capital Mortgage Insurance Services Canada or Canada Mortgage and Housing Corporation. By insuring the mortgage the applicant will be able to receive financing up to 95% of the value of the property. This substantially reduces the down payment requirement and allows more families to buy a home earlier.

Underwriting Conclusion:

After the underwriter has reviewed the entire loan package, there can be four outcomes:


If the loan is "picture perfect" and the underwriter has no questions, the loan will be approved with no conditions.

Approved with conditions ( the most common response):

(a) If the underwriter needs additional documentation before a final credit decision can be made, a conditional approval will be given. In essence, the loan documents will not be prepared until the condition has been satisfactorily met. An example of a condition could be a pay stub to validate the borrower's income.

(b) If the loan can be approved, but a condition must be met prior to closing, a "prior-to-funding" conditional approval will be given. In this case, the loan documents will be prepared and sent to the lawyer, but the lender will not fund the loan until the condition has been met. An example of a "prior to closing" conditional approval could be proof of sale of existing home where the equity will be used as the down payment.


In this case there is insufficient documentation of verification to decide whether or not to approve or decline the applicant. The mortgage lender will request the information and will set the file aside until these items are delivered.


Underwriters will be unable to approve a loan if the loan file has substantial deficiencies and does not meet the minimum standards of the lender or the lender's secondary market investors. Some lenders require that a second underwriter review the loan package before a final denial is communicated to the borrower. Underwriting criteria can be different among lenders and a borrower may be able to find other acceptable financing alternatives in the market place.

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