One of the first questions that I get from a client when we sit down is... How much mortgage do I qualify for?
Two income based ratios, the Gross Debt Service (GDS) and the Total Debt Service (TDS), are used to calculate how much mortgage you qualify for. The GDS Ratio can not exceed 39% and the TDS Ratio can not exceed 44%. As a rule of thumb, the qualifying mortgage would be 4.5 times your annual income. eg. $100k annual income would qualify for $450k.
OK. Now, let me clarify! The above ratio is a very generic rule of thumb. Lenders evaluate every application based on more than just your income.
There are 5 factors that lenders use to underwrite any borrowers application. These 5 factors are:
Character, Capacity and Credit are like 3 foundational legs of a stool. All of these must be solid for a borrower to be approved. If one of these legs is weak, then the lender will consider the other two factors, namely Capital and Collateral to shore up the weaker leg.
For Character, the lender looks at an applicants stability and would consider questions like... Have they moved around a lot or lived in one place a long time? Has the applicant had 7 jobs in the last 3 years or just one for the last 10 years? Does the applicant have good savings habits? Is the applicant good with their bills?
For Capacity, the lender will use the TDS & GDS calculations to determine what the maximum numbers are.
For Credit, the lender will review the applicants credit report. To qualify for a mortgage with less than 20% down, an applicant should have a score over 650.
Capital refers to an applicants net worth and how much liquid assets does an applicant have access to.
Collateral, when applying to purchase a home, would be the property. The lender would also consider the amount of mortgage versus the value. To shore up risk, a lender could ask for a larger down payment.
Assuming that all of these 5 factors are acceptable to a lender, then the rule of thumb that I gave earlier would apply for a home purchase.
Let's look at some examples. Let's assume an income of $100,000 and that I'm using 5.34% as the qualifying mortgage rate.
Example 1: Borrower has a car lease of $420/month & no other debt. Property taxes estimated at $3,150/year. Home purchase (no condo fees). Borrower qualifies for a mortgage of $460,000
Example 2: Borrower has a car lease of $755/month and no other debt. Property taxes estimated at $2,900/year. Home purchase (no condo fees). Borrower qualifies for a mortgage or $410,000. (note: the car lease reduces the qualifying mortgage amount)
Example 3: Borrower has a car lease of $420/month and no other debt. Property taxes estimated at $3,000/year. Condo purchase, condo fees of $400/month. Borrower qualifies for a mortgage of $430,000.
As you can see from these 3 examples. The amount of debt affects the amount of mortgage that you will qualify for. Condo fees also affect how much you could qualify for.
How is the Gross Debt Service Ratio Calculated?
To calculate the GDS Ratio, we add up the monthly cost of the mortgage principle and interest, the property tax cost, an estimated heating cost and half of the condo fees if applicable. This is then divided by the total income before income tax.
This GDS Ratio can not exceed 39%.
Depending on the amount of down payment and the lender, this number could be higher or lower. Typically, for home purchased with less than 20% down, this ratio is fairly strictly followed.
For purchases with 20% down or more, some lenders will only allow a GDS ratio up to 32% or 35% and other lenders could allow up to 44% for the GDS ratio.
These differences really highlight the need for you to work with a professional who knows and understands the choices available to you through different banks, lenders, trust companies, credit union and monoline lenders.
How is the Total Debt Service Ratio Calculated?
To calculate the TDS Ratio, we add up all the monthly home costs which we already calculated with the GDS Ratio. We also include minimum credit card payments, more specifically 3% of the outstanding balance. We would include a 3% payment on any outstanding revolving credit, like credit cards, lines of credit, etc. We would also include minimum loan payments and minimum lease payments.
This total is then divided by the total gross income before income taxes and the TDS Ratio can not exceed 44%.
As with the GDS ratio, the TDS ratio is adhered to quite closely with purchases where there is less than 20% down.
When purchasing with 20% down or more, some lenders will allow a maximum TDS ratio of 40% and others will allow ratios upwards of 55% or 75% depending on the down payment.
As I had said before, working with a professional is key here to see what works for you.
If I have 20% Down or More, Is The Qualifying Criteria The Same?
When you have 20% down, the mortgage no longer requires default insurance by one of the three Canadian default insurers. After January of 2017, the government changes to default insurance and qualifying criteria changed the playing field for lenders.
For some smaller lenders, it's more expensive to lend to a client with 20% down as compared to a client with less down. These lenders therefore protect themselves by increasing their requirements and will make the qualification criteria more strict than for insured mortgages. For example, you would see max GDS ratios of 32% and TDS ratios of 40% here.
When clients have 35% down or more, the playing field evens out.
For other lenders with more cash on hand, they can be a little flexible with the 39% and 44% but they don't want to get too far away from these ratios as there is more risk of default the higher these calculated numbers are.
Lenders in the alternate lending space will allow higher TDS numbers. The reason they allow higher numbers is that they can take a little more common sense view of a client's income.
For most of the big banks, trust companies, etc., income verification is quite strict. Documented, verified income is all that can be used to qualify an applicant. These lenders don't include income from room mates, or non-guaranteed second jobs or other short term incomes unless there is a 2 year average that has been declared to CRA.
For the alternate lenders, they will include some of these other incomes as part of their qualifying criteria. The rates they charge are higher than traditional bank and trust companies would chard, to reflect the increased risk of including these unstable sources of income.
Always Look At Your Budget, Don't Buy More Home Than You Can Comfortably Afford
This is probably the most important factor to consider. Your lender may say that you can qualify for a mortgage of $450,000 but the payments are much more than you can afford. These calculations do not take into consideration your lifestyle. If you have kids that are doing lots of different activities. If you enjoy traveling and experiencing life, then it's better for you not to push your home purchase to the max of your abilities to qualify.
When I meet with clients. I always review both numbers. I review how much the lender will qualify the client for. I also review your numbers to see how much you can afford and what that equals in terms of mortgage amount.
Let's look at another example. In example 1 above, we have a client who earns $100,000, has a car payment of $420/month and no other debt who qualifies for a mortgage of $460,000.
That mortgage payment would be $2,175/month, property taxes would be $270/month. Total payment for her home is $2,444/month
When she reviews this number she should also include other costs associated with her new home. House insurance will cost her $125/month, Utilities for her new home will be approximately $400/month.
If she purchase that home and had a mortgage of $460,000, her monthly housing costs will be $2,969/month
She currently rents for $2,000 per month, her utilities are included, her tenant insurance is only $25/month. She needs to make sure that she can afford an additional almost $1,000/month for her own home.
She has been building her savings up every month and has contributed close to $1,000 per month for the last year. So for her, the numbers work and she could afford the home. She would sacrifice some ongoing savings, but she could find a room mate to help contribute to her housing costs.
This type of analysis is so important. When you try to figure out how much you can qualify to purchase a home, don't just use the bank's calculation.
Review your own expenses and income. Make sure that you can afford the payments. That way, you can make an informed decision about how much home you want to buy.
If you would like to review these calculations, please connect with me.
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