The Lender’s Equations: How Much Mortgage will you Qualify for?
Knowing how much you can reasonably, comfortably and responsibly contribute to home ownership is paramount in your making a wise and sound investment on your Canadian property. The big four factors that generally contribute to this mortgage amount are:
- Monthly income generated
- The amount you can contribute to your down payment
- The mortgage interest rates and term you qualify for
- Other financial commitments or debts you are obliged to pay
Lenders basically use two rules to determine the mortgage you are eligible to be funded to receive, in addition to examining your credit history and FICO score:
- Gross Debt Service Ratio (GDS)
- Total Debt Service Ratio (TDS)
The Gross Debt Service Ratio (GDS) includes mortgage payment (principal and interest), heating expenses and property tax (referred to in the mortgage industry as PITH), as well as 50 per cent of any applicable condominium fees. GDS should equate to 32 per cent* or less of your gross qualifying income.
The Total Debt Service Ratio (TDS) includes your total monthly debt obligations (vehicle payments, student loans, credit card payments, child or spousal support payments, etc.), and should equate to 40* per cent or less of your gross qualifying income.
Here we will site two examples of a qualifying income toward a mortgage and a financial situation:
Example 1: John currently earns $5,000 in gross monthly income. The property he is examining would entail a mortgage payment, tax installment and heating bill totaling $1,350 per month. John also pays a luxury vehicle loan of $600 per month.
To determine John’s GDS, we use $1,350 and divide this number by his gross monthly income, $5000, = 0.27 or 27%. John is under the allowable ratio of 32% for GDS.
To determine John’s TDS, we must use his housing payment from above and we must add his vehicle loan of $600, so the total is $1,950. We must then divide this number by his gross monthly income, $5,000, = 0.39 or 39%. His TDS equates 39 per cent of his gross qualifying income, just under the allowable 40%.
John qualifies for the loan he is seeking as his GDS is 27% and TDS is 39%.
Example 2: Joanne takes home a monthly gross income of $5,000 as well. But Joanne also pays $300 per month on credit card debt, $200 per month on a student loan repayment, and $200 per month on her car loan. The home she is hoping to finance would cost a monthly $1,550 to cover the mortgage payment, heating bill and property tax.
To determine Joanne’s GDS, we use $1,550 and divide this number by her gross monthly income, $5000, = .31 or 31%. Joanne is under the allowable ratio of 32% for GDS.
Joanne’s total monthly expenses total $2,250 ($1,550 for housing costs above and $700 for her other monthly obligations). We must divide that by her gross monthly income ($5,000), her TDS equals 0.45 or 45%. In a lender’s eyes, Joanne’s TDS is five per cent over the desired 40 per cent TDS a lender is looking for.
Joanne would not qualify for the loan she is seeking as her GDS is fine, but her TDS is higher than the allowable ratio.
An online Canadian mortgage calculator can assist you in determining your monthly expenses to gross monthly income. You can use a mortgage calculator to determine your expected mortgage payments over a fixed term with a set mortgage rate, and add to this the monthly expenses you know you are committed to paying over the next years of your mortgage term. Taking this step will greatly improve your knowledge of the mortgage amount you truly can afford, and keep you focused on only properties that fall within this range.
*Note: 32% GDS and 40% TDS are CMHC’s guidelines, but there are other insurers that will allow higher ratios (35% GDS and 42% TDS) and even higher than that based on credit score.