Does mortgage pre-approval affect credit score?

Purchasing a home is a big financial commitment. From house hunting to getting a mortgage and closing the deal, there are many steps before you officially move into your new house.

There's plenty to consider regarding budgeting, mortgage options, and interest rates. Many Canadians likely start saving for a home years in advance and have savings for a down payment. However, you probably still need a mortgage to finance your purchase.

Whether you're a first-time home buyer or relocating to a new neighborhood, qualifying for a mortgage in Canada can be daunting. You think about how much savings you have, how much mortgage you need, the current mortgage rates, amortization periods, and down payments.

Getting a mortgage pre-approval is part of the buying process. The mortgage pre-approval gives you an accurate estimate of money you can expect to be approved for by a mortgage broker. The mortgage pre-approval process assesses your assets, debts, income, and financial obligations.

Mortgage brokers also review your credit score as it's an important indication of your overall financial health. Your credit score and mortgage loan are closely related because they can impact each other. It's important to understand the relationship so you can make informed decisions about your finances.

What is a mortgage pre-approval?

A mortgage works by lending money to a prospective homeowner to finance the purchase of the house. A mortgage pre-approval is when a mortgage lender checks your credit and verifies your financial information. The mortgage approval process provides detailed and accurate information about the maximum amount of mortgage you qualify for, mortgage payments, and lock-in an interest rate for 60 to 120 days, depending on the lender.

For mortgage pre-approvals, lenders typically review your personal information, proof of employment, assets and debts, and credit score. The credit check helps lenders assess your credit risk and determine whether they want to qualify you for a mortgage and the amount. The pre-approval process may look different based on the lender's criteria.

The pre-approval process is a significant milestone in your homebuying journey because it helps you plan your finances better and brings you closer to moving into your dream home. However, the pre-approval doesn't guarantee you a mortgage. You must meet the qualifications set by the mortgage lender to secure the mortgage.

Mortgage pre-approval vs. pre-qualification

The mortgage pre-qualification process is more casual than the pre-approval process. You get a less formal version of your pre-approval, which provides a loose estimate of what a lender may be willing to give you. You provide the lender with your general financial situation, like income, assets, and debt. You're likely still shopping around and exploring your options.

Pre-qualification is typically the first step in the mortgage process. As a preliminary step, the numbers you see are subject to change. It's important to discuss your mortgage needs and financial situation with the mortgage broker and understand the different mortgage and financing options available. There are no credit inquiries made during the pre-qualification process. You can get a pre-qualification over the phone or through an online assessment.

The mortgage pre-approval process is step two and happens after you get a pre-qualification. When you're more serious about buying a home and are ready to secure a mortgage, you can apply for a pre-approval to get a more accurate amount of what you may qualify for. Lenders conduct a credit check to verify your financial health and ability to finance a home purchase.

Getting a pre-approval is more formal and lengthy, as you're required to complete the full mortgage application process. Lenders ask you to provide more documentation, like expenses, financial obligations, identification, and proof of capital. Lenders may also want to see pay stubs to verify your salary, a letter of employment to verify your employment length, and a notice of assessment from the CRA if you own a business.

What determines my mortgage pre-approval?

Several factors determine your mortgage pre-approval success. You provide the mortgage lender with your personal and financial information, and they conduct an in-depth analysis of your eligibility. Since a mortgage loan is a huge debt, lenders do their due diligence to ensure they reduce the credit risk as much as possible. Here's what lenders look at.

Income

Your income is a huge factor in determining whether you can afford monthly payments on a mortgage. Not only are you paying off the principal, but you're also paying interest on your loan. A higher income may qualify you for a larger mortgage as you can afford a higher monthly payment. Some mortgage loans are designed for low- to moderate-income homebuyers or first-time homebuyers, so they may have lower income requirements.

Debt-to-income ratio

The debt-to-income ratio is the percentage of your monthly gross income going toward paying debts. A higher ratio indicates a lot of debt, which increases your credit risk if you get a mortgage, as it's a huge debt undertaking. A 35% or less debt-to-income ratio is generally favourable as your debt is manageable if you have healthy financial habits and you likely have money left after debt repayments.

Proof of employment

Proof of employment verifies your pay stub with a company and the length of your employment. It shows lenders you have a reliable source of income and the regular income needed to make monthly payments. A letter of employment assures lenders of your financial stability and reduces your risk of defaulting on loans.

What credit score do you need for a pre-approved mortgage?

While credit score requirements for a mortgage pre-approval might vary between banks, the minimum required credit score for a mortgage is typically 680. A credit score of or above 680 can easily increase your chances of getting approved for a mortgage.

Mortgage providers strike a balance between providing an opportunity to buy a house and ensuring borrowers can pay their monthly payments. A score of 680 shows the lender that you are a prudent candidate for a loan and that your risk of defaulting on your mortgage payments is low.

Some people could be locked out of the housing market because of poor credit. It deprives them not only of the opportunity to get a home but also of building housing equity. There are a couple of ways of dealing with poor credit.

First, the obvious one is to build credit, which takes time and patience. Ensure you’re on top of your other debt payments and are consistent over time so your score will return to 680 and beyond.

Another option is to contact mortgage providers who specialize in working with clients who have poor credit and can help you figure out your best path forward for a mortgage.

Is a mortgage pre-approval a soft or hard credit inquiry?

A mortgage pre-approval typically requires a hard credit inquiry. The lender will access your credit report and assess whether you meet the eligibility criteria for the loan.

This inquiry will show up in your credit report and can impact your score by a few points. But worry not because this impact is temporary. Your affected points can increase in a few months with good financial and credit management skills.

Does a mortgage pre-approval impact your credit score?

Each mortgage pre-approval has a hard credit inquiry to verify your financial information and assess your credit risk. The hard inquiry pulls information from your credit report, like your credit utilization ratio, credit history, amounts owed, and payment history. A hard credit inquiry can impact your credit score temporarily. While you can get multiple mortgage pre-approvals from multiple lenders, too many hard credit checks can lower your creditworthiness and make it harder to secure a mortgage.

However, your credit score can change monthly, and consistent positive financial behaviours can fill any dent caused by a hard credit check. As long as you consistently pay off your debts, maintain a good credit utilization ratio, and use credit responsibly, a hard credit check typically doesn't affect your credit score for long.

How long is a pre-approved mortgage valid for?

A lender can lock in a mortgage pre-approval rate for up to 120 days. If interest rates increase during the period, the mortgage broker typically honours the locked-in rate if you meet all other mortgage conditions. The mortgage broker can also lock in the terms and principal amount of the mortgage loan, which determines the amount you get for the pre-approval, amortization period, and monthly payments.

When should you get a mortgage pre-qualification and pre-approval?

While mortgage pre-qualifications and pre-approvals aren't mandatory, they can open up discussions about your financing needs and give you a better chance of securing a mortgage. A mortgage pre-qualification is your chance to learn about various mortgage options, interest rates, and terms. You can get a pre-qualification over the phone or online, and there's typically no associated costs. It gives you an estimate of your loan based on basic information like your income, assets, and debts.

You can get a pre-approval when you start thinking about buying a house. It's a preliminary step to teach you about your options and decide what makes the most sense for your current financial situation. You can ask questions or voice concerns about your approval odds, needs, and obligations. The mortgage broker or lender can work with you to find the best option that suits your financing requirements and situation. The pre-qualification process typically takes a few days to complete.

After you get a pre-qualification, or when you're almost ready to make an offer on a house, you can apply for a mortgage pre-approval. A mortgage pre-approval doesn't guarantee a mortgage loan, but it can increase your chances of securing one. During the pre-approval process, the lender conducts a hard credit inquiry, which can affect your credit score, and a detailed analysis of your ability to purchase a home.

Lenders carefully review your income, debts, assets, proof of employment, financial obligations, equity, and other information to assess your creditworthiness and financial stability. They are more likely to provide a pre-approval to someone with a good credit history, high credit score, consistent payment history, and stable income as they are more likely to follow through with the mortgage terms and payments.

Mortgage vs. home equity loan

Understanding the differences between a mortgage vs. home equity loan helps you make informed choices about borrowing money. A mortgage is a loan given to help you finance a home purchase. The lender pays for part of your home with the understanding you'll repay the principal and interest over the term of the loan. A home equity loan lets you borrow money against the equity of your home.

Your home equity is the value of the home you own. If your house is worth $1,000,000 and your mortgage is $600,000, your home equity is $400,000. You can use a home equity loan to buy anything you want. However, you deduct fees from the size of your loan, such as title fees, insurance payments, and the cost of appraisal.

You can get a second mortgage or a home equity line of credit (HELOC). A HELOC is revolving credit. You can borrow as much as you like up to your limit. Interest rates can vary and fluctuate quite a bit with the financial market. A second mortgage is when the lender takes out a lien on your property and gives you the balance of your loan. You repay it the same way you do with your original mortgage.

What does a mortgage pre-approval letter look like?

You get a mortgage pre-approval letter when you get pre-approved for a mortgage loan. The letter states how much you can borrow based on the information you provided, but it isn't a guarantee. Your final loan amount, interest rate, and terms will be confirmed during the full underwriting process. It also outlines the conditions you must meet to get your loan.

The mortgage pre-approval letter is a useful tool because it indicates an accurate estimate of what you'll likely see in your mortgage. You can use this letter when planning a financial strategy to buy your house and manage other debts, like car loans, childcare, and bills. Mortgage payments are a long-term commitment, so you can use the mortgage pre-approval letter as an estimate of your mortgage debt when determining your budget.

How to prep your credit for mortgage pre-approval

Several factors affect your credit score in Canada. It's a good idea to ensure your credit score is in a good place before applying for a mortgage pre-approval. You can follow these steps to prepare your credit for a pre-approval:

• Don’t apply for any credit products that do a hard credit inquiry. This will impact your credit score and, thus, your pre-approval.

• Don’t close any credit accounts you might have. Sudden recent changes may attract scrutiny.

• Pay your bills on time.

• Minimize your debt. This also includes credit card bills or lines of credit you might’ve opened.

Can I secure an interest rate with a pre-approval?

You lock in a pre-approved interest rate when you get a mortgage pre-approval. The lender keeps this interest rate for up to 120 days, depending on the lender. Even if the interest rate shifts with the market, you keep the pre-approved interest rate during the locked-in period. It gives you time to organize your finances and decide whether to take the mortgage.

Does the interest rate depend on the length of mortgage pre-approval?

Banks will typically lock in the pre-approval interest rate for a set period. It can be 60, 90, or 120 days, depending on the lender. If the interest rates increase, you maintain the locked-in rate. If the rate decreases during the locked-in period, you get the lower interest rate. You still need to maintain good credit throughout this period. After this time, your rate might change.

Building your credit score to finance your dream house

Your credit score plays a huge role in getting a mortgage pre-approval. Credit bureaus take information from your credit report to give you a three-digit score assessing your overall financial well-being. A good credit score indicates sound financial health, while a lower score may indicate financial and credit management challenges.

Mortgage lenders love high credit scores, as they prove you can manage debt responsibly, which lowers their credit risk of giving you a mortgage. Build your credit with KOHO with a secured line of credit, a KOHO line of credit, or a combination. We help you improve your credit score faster to get the mortgage pre-approval you want.

An essential part of having good credit is strong financial skills. The virtual credit card helps track your spending habits and set limits based on your budget. Whether you're trying to cut expenses to manage your bills from a single platform, we make it convenient for you to spend from your virtual wallet and pay off your balance on time each month. Routinely get a free credit score report to ensure you're on the right track for the mortgage pre-approval process.

If you're worried about going over your credit limit, you can sign up for Cover, a subscription-based overdraft protection coverage service. Cover lets you borrow up to $250 in zero-interest cash advance for unexpected expenses that push you over your limit. You don't have any fees as long as you repay the balance and pay the subscription fee.

Learn more about how KOHO can get you closer to your financial goals. Whether you're looking to earn interest on your down payment savings or ensure your credit score is in check, we've got your back.