Mortgage Qualification Basics
When it comes to qualifying for a mortgage, the current debts you have affects the mortgage amount you can qualify for. I often see buyers who have worked hard to maintain a good credit score and saved up the downpayment, then I have to tell them they don’t qualify at the price they want to buy in due to the car payment they have! It’s not really something any potential homebuyer wants to hear, so this week I want to go over the basics of mortgage qualifying which you should think about before taking on any new debt before you consider buying a home.
When calculating a mortgage that is affordable for you, we use two formulas and apply them to your specific financial profile. These are the key terms you need to keep in mind when you start preparing for the mortgage approval process.
GDS Ratio- Gross Debt Service Ratio
These are the costs attributed to housing such as mortgage payments, property taxes, heat, and condo fees if applicable, usually cannot take up more than 32 -39% of your gross annual income depending on your credit score and the lender. There are exceptions though they may only be available to you through an alternative lender, which means you may have to pay a higher interest rate and have a larger downpayment requirement.
What is included in your gross annual income varies depending on your type and years in your line of work. To determine what is the maximum income you can use to qualify, schedule a discussion with your mortgage professional.
TDS Ratio- Total Debt Service Ratio
The potential housing costs as mentioned above PLUS any existing debt payments you already have cannot total more than 40 -44% of your gross annual income. If you need to go higher than the 44% maximum, be prepared to take the alternative route, which is usually accompanied by higher rates, a potential fee, and likely a larger downpayment requirement. The TDS ratio is where a high car payment makes a big difference. The TDS takes into account your other monthly debt obligations and adjusts the maximum mortgage amount you can qualify for based on your current payment commitments. The more “room” those personal debt payments take up reduces the amount left to cover housing costs. When you have less to cover housing costs, your buying power is reduced to properties that fit within your mortgage and downpayment budget.
To put it into perspective, here is an example of how a vehicle payment can affect your mortgage qualifying ratios;
This example applies to a potential mortgage borrower who earns $50,000 gross income per year, owes $5000 in credit card balances who needs a vehicle in the near future:
Scenario 1: Work with the car you have, borrow a family vehicle, use public transportation, or buy a vehicle in cash so a monthly payment is not involved;
Maximum mortgage amount qualified for: $230,184
Monthly mortgage payment: $1,030*
Scenario 2: buy a vehicle with a $350 per month payment
Maximum mortgage amount qualified for: $192,937
Monthly mortgage payment: $864*
Scenario 3: buy a vehicle with a $500 per month payment
Maximum mortgage amount qualified for: $159,415
Monthly mortgage payment: $713*
That is a difference of $70,000 in some cases- you could buy 2 garages for that! It doesn’t have to be a car payment that craters your qualifying power, simply, the higher your income amount, the less effect a small vehicle payment will have on your mortgage affordability calculations. Best way to maximize your mortgage affordability is to reduce debt. There a few other tips I want to pass on to help you qualify for a mortgage solution that fits your needs.
Timing is key and if you’re trying to qualify for a mortgage now or in the near future, think twice before you take on any type of new debt. This includes credit card debt, vehicle loans, lines of credit or “don’t pay for a year”. If it is a necessary expenditure, try to delay it until after you’ve completed your mortgage financing.
If you can’t avoid taking on a new debt while trying to qualify for a mortgage at the same time, try to spread out the time to pay it off for as long as you can to keep the payments low. This applies more specifically to vehicle loans as you can always pay extra over and above the regular payment amount if you have the funds available.
If you have existing debts that you’ve been working to pay off and you want to apply for a mortgage now, team up with an experienced mortgage professional who can help you restructure your debt in a way that will help you maximize your mortgage affordability.
It’s kind of a double-edged sword because you need debt to build credit and maintain a good credit rating, though too much debt can affect you negatively. Be sure to keep a close eye on your debt levels to ensure they’re helping you improve your financing profile rather than to hinder it. If you want to calculate the maximum mortgage amount you can qualify for and see how a debt can affect it, contact a trusted mortgage professional or plug the numbers into an online calculator though be sure it’s applicable to mortgages in Canada.