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Most homebuyers need a mortgage to help make their dream of home ownership a reality. Before you start House Hunting, it's best to get pre-approved for a mortgage to determine exactly what you can afford.

How do I get Pre-Approved?

A lender (such as a bank or private lender) will make a decision to approve or decline an application for a mortgage based on the "5 C's" of credit. The 5 C's of credit are as follows:

1. Character 
2. Capacity
3. Credit
4. Collateral
5. Capital

Character

Lenders base Character on two components which are Stability and Net Worth. Stability includes consistency in length of employment, type of job, length of residence, how long reported on credit bureau and how credit has been repaid. They genereally look for a minimum of 3 years worth of history. If there is a break in the consistency, you will require a reasonable explaination in order for the lender to make a prudent decision.

Net Worth is the amount of assets less liabilities. Net Worth is usually accumulated over time and lenders take this into account along with the age, job stability and income of the applicants. These factors will determine if the Net Worth is reasonable.

Capacity

Capacity indicates the ability to repay all current obligations plus the new mortgage request. The capacity is determined by using certain standard mathematical calculations that take personal income, existing debt load and the mortgage financing the customer is applying for. These ratios are commonly referred to as G.D.S.R and T.D.S.R.

Credit

Credit determines the manner in which the applicant has repaid existing and previous credit. A good credit history demonstrates the applicants willingness to repay debt. This willingness to repay is essential.

Collateral

The collateral is also referred to as the security. This would be the property being mortgaged. This component concerns the lender should they have to exercise their right to take action against the applicant for lack of repayment. In consideration of this, the marketability of the property is imperative. Marketability includes many factors, they are property type, condition, location, zoning, value of property at the time of mortgage request. This can be verified by the listing as well as an appraisal report.

Capital

Capital reflects the amount of equity that the applicant has or will have (depending on the purpose for which the credit is obtained) in or for the property. These are standard policies/conditions as to the minimum amount of capital or equity that is acceptable in order to qualify for a mortgage, which again depends on the purpose of mortgage request. It is common sense that an individual who invests capital in a property will more likely feel obligated to protect their own investment to prevent financial loss. This justifies the request of lenders that the capital be from non-borrowed resources and supplied from the applicat's own resources.

In conclusion, a prudent lending decision is based on the strengths and weaknesses of the 5 C's of Credit. If one piece of the puzzle is weak the other pieces must be pooled together to compensate and they should out weigh the weak piece.

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Reference: Toronto Real Estate Board