According to Fitch Ratings' Canadian Residential Mortgage Loan Loss Model, there are six primary factors that influence mortgage defaults. These include borrower equity, borrower credit score, total debt service ratio, loan purpose, occupancy and property type.
A mortgage borrower's equity is the difference between the value of a home and value of all mortgage secured against it. As a borrower pays off their home loan, they build equity. This can be a valuable asset to homeowners, as the more equity that's built up in a home, the more that can be accessed through home equity loans or home equity lines of credit. This essentially allows homeowners to turn the value of the home into cash for any number of purposes, including renovations, college tuition or medical costs.
When it comes to home loans, a borrower's credit score essentially acts as a representation of their reliability. A higher credit score shows lenders that a borrower is financially responsible and has a history of staying up to date with their financial obligations. A higher credit score also helps borrowers obtain better mortgage rates, as lenders are more likely to offer lower interest on a loan to borrowers who pose less of a risk.
Total debt service ratio
In addition to credit ratings, lenders use debt ratios to analyze a borrower's ability to repay a mortgage. A total debt service ratio is the percentage of a borrower's income that is required to cover housing costs, as well as any other monthly debts that a borrower must pay, such as credit cards and auto loans. While the limit for a total debt service ratio is typically 40 percent, this figure can be raised if a borrower's credit score is high enough.
Loan purpose relates to why a mortgage was obtained in the first place. For instance, was the loan for a new home purchase or to refinance a current mortgage? The purpose of the loan can have a major impact on its terms and interest rate. As an example, a loan for a first-time homebuyer is likely to have more stringent repayment terms than that of an older homebuyer who is refinancing into a lower mortgage rate.
Occupancy concerns whether a home loan is obtained by a traditional homebuyer or an investor. Whereas most homebuyers obtain mortgages in order to purchase a primary residence, investors seek home loans in order to buy properties and then sell them at a higher price.
The classification of a property depends on the type of home it is. For instance, there's a big difference between a single family home and a multi-family property. Additionally, purchasing a detached home is a lot different from investing in a condominium. Different property types come with different strings attached, all of which can affect the home loan process.
While these six factors are highlighted as those that most influence whether a mortgage will default, the success or failure of a borrower's ability to repay a loan ultimately comes down to one thing: planning.
A borrower who rushes into a home purchase without making sure that they can afford it will either find themselves defaulting on a loan or buckling under major financial stress. One of the best ways to plan ahead and ensure that a borrower can repay a mortgage is by using an online mortgage calculator. These tools are free and easy to use, allowing mortgage borrowers to plug in information regarding pertinent information to calculate how much they will owe, how long it will take to pay off and how much their payment will amount to.