I Dislike Mortgage Pre-Approvals And You Should Too

Toronto's real estate spring market is about to get started or some might argue it has already begun with a semi-detached in The Junction selling for $210,000 over asking with 32 offers, yes 32 offers!  The spring real estate market is the hot season where most transactions are made since many buy in the spring with closings in the summer before schools start in September.  One thing you will hear many times from real estate agents, mortgage brokers and bankers is "Get Pre-Approved".  I dislike mortgage pre-approvals for the following reasons:

1. Pre-Approvals Underwriting

Pre-approvals are underwritten conservatively relative to an actual deal.  The Gross Debt Service Ratio (GDS) and Total Debt Service Ratio (TDS) requirement for pre-approvals is 32/40, however real deals can go up to 39/44.  This means a pre-approval purchase value will be lower than what a buyer can qualify for.

2. Interest Rate Variations

This is where things get really tricky.  Some lenders add a premium (safety buffer) to pre-approvals, typically 0.1%, since they do not know the exact cost of funding off the bond market until there is a deal with a closing date.  Furthermore, lenders have different rates based on:

1. Closings within 30 days, 45 days or 120 days
2. Deals that are insured (less than 20% downpayment)
3. Features built into the mortgage (fully loaded vs no frills mortgage)
4. Occupancy of property: owner occupied or rental
5. Some lenders won't do pre-approvals

Get Pre-Qualified

What I do with all my buyer clients is get them pre-qualified per the following steps:

1. Complete financial analysis and mortgage application
2. Establish a monthly cash flow budget
3. Get a rate hold in a rising interest rate environment
4. When they see a property they want to put an offer on, I complete the mortgage qualification analysis based on the property details to establish a maximum price for a bidding war scenario

The fourth step is critical since my clients are emotionally ready to walk away from a property after they have established the maximum price they are willing to pay. So far, they have been quite successful.

In conclusion, pre-approvals are nothing more than a rate hold which is a good thing to obtain in a rising interest rate environment which doesn't look like is happening anytime soon.

If you are looking to dive into Toronto's hot real estate market and win a bidding war, please contact Nawar.

Caught In A Bidding War?

Toronto's real estate has been active for many years now with the exception of late 2008 and early 2009 when the economy contracted.  Ground level (townhome, semi-detached and detached) homes have had considerable shortage on the supply side creating bidding wars which is considered normal in Toronto.

Bidding Wars

Bidding wars are set up to maximize the selling price and benefit from potential buyers' emotions during the multiple offer process.  However, lenders require appraisals done on the property to obtain "market" value to lend on.  What if there is a discrepancy between the purchase price and appraisal value?

Example:  

Purchase price: $850,000. Appraisal value $820,000.  Mortgage amount: $656,000 (80% of $820,000) not $680,000 (80% of $850,000).  The buyers are short $24,000.

Possible Solutions:

1. Buyers happen to have additional funds to cover the shortfall
2. If buyers don't have $24,000, a second mortgage can be arranged for the $24,000.  Keep in mind not all lenders allow second mortgages behind their first mortgage.  Knowing which lenders do is important
3. Gifted funds from family of $24,000
4. Pull equity from other properties through a line of credit or refinance.  The additional debt would have to be calculated into the overall debt service ratios (GDS/TDS)

Due diligence is required especially for cases where a home was bought in a multiple offer situation and the buyers have to sell their home. What if the buyers don't get the desired selling price for their home? What if the two closing dates are far apart?  Should one buy or sell first?

http://youtu.be/71csf00xqE0

Consult a mortgage professional upfront to run through the scenarios to have contingency plans just in case. Also work with real estate agent who specializes in the local area and has the pulse of the neighbourhood's real estate market.  To discuss whether you should buy or sell first or plan buying your next home, please contact Nawar.