Qualifying for a Mortgage
How big of a mortgage can I afford? Is one of the first questions I get asked when talking with new home buyers and prospective clients in need of a mortgage. Its often asked quickly over the phone, however the answer to that question can take a little longer…here’s why.
Canadian Mortgage Lenders, Banks, and Mortgage Brokers will use your financial information to determine which mortgage options are available to you and how much you qualify to borrow.
Factors such as the stability and history of your income, your credit history as reflected on your credit bureau, outstanding debt obligations, the home you are wanting to purchase, and how much (if any) of a down payment you have, will play a roll in determining how much mortgage you qualify for.
Given your income and current debts, mortgage lenders will use two financial calculations to help them assess how much of a mortgage you can afford:
• Gross Debt Service Ratio (GDS)
• Total Debt Service Ratio (TDS)
Mortgages in Canada with less than a 20% down payment must be insured against default. Canada Housing and Mortgage Corporation (CMHC) have ratio guidelines of 32% of your gross income for the GDS ratio and 40% for the TDS ratio. The mortgage lenders will use these ratios to determine the maximum amount they can lend you.
What is the GDS ratio?
Gross Debt Ratio (GDS): Is the percentage of your gross income (before deductions such as income tax) required to cover the costs associated with your home, such as mortgage payments, property taxes and heating. If you are purchasing a condo half of the monthly condo fee will be included in this calculation. The GDS ratio should not exceed 32% of your gross income.
What is the TDS ratio?
Total debt service ratio (TDS): Is the percentage of gross income (before tax deductions) required to cover the costs associated with your home, such as mortgage payments, property taxes and heating, plus other debts, such as minimum credit card payments, car loan and lease payments and lines of credit. The TDS ratio should not exceed 40% of the home owner’s gross income.
Calculating your GDS and TDS ratio
If you have less than a 20% down payment, and are applying for a variable rate mortgage, or a mortgage with a fixed term of less than five years, federally regulated financial institutions will use the five-year Chartered Bank Benchmark Rate for mortgages to assess whether you qualify for a mortgage, even if you are planning on getting a shorter term with a lower interest rate!
You can estimate the maximum costs you can afford, given your income and current debts. If you are purchasing a home with a partner, or someone else, you can combine your incomes to reflect the household income.
Calculate your monthly gross income
Gross income is your income before income taxes and other deductions.
Monthly gross income = annual gross income / 12 months
Example: Your income is $60,000 a year, before income taxes and other deductions. Using the formula above, your monthly gross income is therefore:
Monthly gross income = $60,000/12 = $5,000.00
Calculate the maximum amounts you can spend on home costs
Maximum GDS home costs = monthly gross income x 32%
Maximum TDS home costs = monthly gross income x 40%
Example: With a gross monthly income of $5,000.00, here are the maximum amounts you can afford to spend per month on home costs.
Maximum GDS home costs = $5,000 x 32% = $1,600. $1,600 represents the maximum amount you can spend on mortgage payments, property taxes, heating and condo fees (if applicable).
Maximum TDS home costs = $5,000 x 40% = $2,000. $2,000.00 represents the maximum amount you can spend on mortgage payments, property taxes, heating, condo fees (if applicable), but also credit card payments, car payments, alimony and other loan payments.
It is important to understand that maximum amounts you calculate may actually overestimate what you can actually afford. This is because the GDS and TDS ratios do not take into account the extra costs associated with buying a home –for example, unexpected expenses such as major home repairs. For this reason having a home budget prepared in advance is a good idea.
Compare With Estimated Home Costs
To do this, you’ll need to estimate what the costs will be for your new home. If the total costs you estimate are lower than the maximum amounts you calculated, you will probably qualify for a mortgage loan with the lender.
In addition to your down payment, you should set aside 1.5% – 4% of your home’s selling price to cover closing costs, which are payable on closing day. Many homebuyers forget to account for closing costs in their cash requirement.