When shopping for a home it’s important to determine the maximum mortgage and home price you can qualify for. To determine your maximum affordability, lenders take several factors into account, including:
• Your down payment
• Your debt service ratios - which are determined based on your income , the monthly costs associated with owning the home and your monthly debt commitment (How much income do you have coming in versus how much debt do you have going out?)
How Your Downpayment Determines Affordability
Your down payment must be at least 5% of your purchase price, which can limit your affordability. If your down payment amount is fixed at say $15,000, the maximum home you will be able to afford, regardless of your debt service ratios, is ($15,000 / 5%) or $300,000. It should also be noted that home prices $1,000,000 or more require a 20% down payment. Having enough for the downpayment may not qualify you to purchase a home for that given price either, other factors are taken into consideration such as your debt service ratios, as well as other expenses such as land transfer tax, legal fees, etc.
How Your Debt Service Ratios Determine Affordability
Set by the Canada Mortgage and Housing Corporation (CMHC), your debt service ratios – including your gross debt service ratio and your total debt service ratio – are used to calculate the maximum mortgage the lender can offer. This maximum mortgage is then combined with your available down payment to determine the maximum home price you can purchase.
Lenders use these ratios to ensure you can consistently make your monthly payment as they place a limit on the amount of your income that can go towards your housing expenses and monthly debt obligations. If the mortgage you want to take on, forces your GDS or TDS above 32% and 40% respectively, you will not be approved for that amount.
Even if you have $15,000 for a down payment, your GDS and TDS score may only approve you for a $250,000 mortgage. Thus when combined with your $15,000 down payment, your max affordability would be $265,000.
How to increase Your Mortgage Affordability
If you’ve used the mortgage affordability calculator, and you’re unhappy with your results, there are several steps you can take to increase your maximum affordability:
• Increase your down payment – This will give you the ability to increase your affordability and purchase a more expensive home.
• Pay off your debts – This will lower your TDS ratio and free up more of your income for your mortgage payment, ultimately giving you the ability to carry a larger mortgage and therefore more expensive home.
• Increase your income – This is the tougher option, but it will allow you to afford a larger monthly mortgage payment, which will increase the overall size of the mortgage you can afford to borrow and repay. Alternatively, you can apply for your mortgage with your partner, or get a co-signer, such as your parents, to guarantee your mortgage.
A Note About Borrowing at Your Maximum Affordability
Your GDS and TDS ratios are just guidelines, and you do not have to borrow the maximum amount possible. Homeowners have been using more and more of their income to service their mortgage payments, leaving them vulnerable to job loss and interest rate increases.
When deciding what your maximum purchase price is going to be, it’s important to make sure that you have enough room left over in your budget to pay down debt, save for the future, and weather interest rate increases and job loss.
Debt Service Ratios - GDS & TDS
While it's easy to use our mortgage affordability calculator to figure out how much you can afford to borrow for a new home purchase, it's a good idea to understand how lenders calculate the maximum amount they will loan you. The two calculations a lender does are: your gross debt service ratio (GDS) and your total debt service ratio (TDS).
Gross Debt Service Ratio - GDS
To calculate your GDS, lenders try to figure out the proportion of your income you would be paying each month to own a particular property. First, the lender will estimate your annual mortgage payments, property taxes, heating costs and 50% of your condo fees (if applicable). The lender will then add that up and divide it by your gross annual income. If the answer equals less than 32 per cent (industry standard), the lender can feel confident in your ability to pay your monthly housing costs.
Total Debt Service Ratio - TDS
To calculate your TDS, the lender will take the same GDS calculation but add in any other monthly payments you might have to make, including loans or the minimum payments on any credit card debt. So, the lender adds together your mortgage payments, property taxes, heating costs, 50% of your condo fees and debts, and divides the total by your gross annual income. If the answer equals less than 40 per cent (industry standard), the lender will know you have the money to make all of your monthly payments and you will be on track with getting approved for a mortgage.
What Happens if I'm Over the Industry Standard
If either of your answers go over than the industry standards, you may want to save more for your down payment and/or pay off some existing debt before buying. However, the 32% GDS and 40% TDS standards are guidelines, not rules. If you have a high credit score or some valuable assets, you may still qualify for a mortgage, even if your GDS and TDS are slightly higher than the industry standards.