What Lenders Look for Before Giving You a Mortgage

What Lenders Look for Before Giving You a Mortgage

Aside from household income influencing the mortgage underwriting course of action, there are other factors that the lender considers when analyzing the risk of a loan. A credit examination, or credit report on the borrower is basic in calculating the ability to repay the loan. Financial institutions keep records of the borrower’s information such as if past loans were paid on time, credit balances and limits, or the date on which the accounts were opened.

There are certain scores such as the FICO score that determines your credit rating. In the event that the you default on payments, the value of the security becomes of great importance in recovering the investment.

An appraisal of the character is as equally important as the your credit rating. The lending value is a conservative calculate pledged as security for the loan. In some situations, the lender approaches CMHC to quote estimates of the lending value, and what amount they are prepared to insure.

Loan to value ratios and debt service ratios are important considerations in the underwriting course of action. They highlight the level of risk assumed by both parties, and what amount the lender is willing to improvement. Aside from a risk examination, lenders also take into consideration the annual character taxes, and mortgage terms such as the interest rate and the amortization period. A market evaluation is needed to determine the optimal structure of a loan to protect from fluctuating rates.

Mortgage insurance is required by lenders (bank or credit union) from homeowners who acquire loans that are more than 80% of their new home’s value. The lender submits the mortgage application to CMHC (or private insurer; Genworth, AIG) for approval of insurance coverage. When borrowers default on their mortgage payments, the lender will be paid out by the insurer for the amount of the debt after the character has been foreclosed.

CMHC pays out 100% of the amount deficient to the lender, while private insurance companies only pay out 90%. It is stated that two thirds of mortgage insurance in Canada is largely controlled by CMHC, the predominant high ratio mortgage company in the market. As of 2010, CMHC insured mortgages worth nearly $500 billion.

CMHC is backstopped by the government of Canada, which secures them with bailout protection. It is stated that CMHC’s mortgage insurance book now backstops mortgage lending equivalent to more than 30 percent of Canada’s gross domestic product. In the event that payouts go beyond the premiums collected, the government backstops CMHC 100%, while private companies receive only 90%. The premium for such insurance amounts to 1-4% of the buy price which is charged to the lender who in turn passes the cost on by adding it to the mortgage amount. Private insurers have the higher interest rates.

In a healthy market, these insurers make a killing in premiums, because there are not many foreclosures, hence not much pay-outs. This ‘paper’ can be bought and sold by investors, as ‘mortgage backed securities’. The proliferation of ‘liar loans’ (subprime borrowers) in the US housing market made all this ‘paper’ worthless and caused a domino effect that culminated in the Credit Crisis in late 2008.

The taxpayers ultimately are the ones on the hook. This gives CMHC an unfair advantage over the private companies, as investors will buy CMHC ‘paper’ over private insurance ‘paper’ because of the 100% guarantee by the government, which creates a vicious cycle as thePI’s need to go into the market to raise capital from investors, as opposed to CMHC using government money.

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