There is a lot of focus on consumer debt lately, and for good reason. The latest TransUnion report indicates that British Columbians carry the highest average debt loads in Canada at $37,879. This is outside of mortgage debt. Debts that can start to add up and affect the size of mortgage you qualify for (and purchase price of your home) are primarily credit cards, lines of credit, car loans and car leases. The TransUnion report also mentions that there has been a large increase in car loan debt lately, most likely due to very low lending rates. Understanding how your debt load can reduce your home purchasing power is a key factor that you should consider before talking to your bank about a mortgage.
The amount of mortgage you qualify for primarily depends on your income, your down payment and your “other” debt payments. Following are the two standard calculations that lenders use:
Gross Debt Service Ratio (GDS). Generally, no more than 32% of your gross annual income should go to "mortgage expenses" such as principal, interest, property taxes and heating costs (plus maintenance fees for condo mortgages).
Total Debt Service Ratio (TDS). TDS evaluates the gross annual income needed for all debt payments including mortgage, credit cards, personal loans, car loans, etc. TDS payments should not exceed 40% of your gross annual income. The combined income for you and your spouse is usually considered when determining this ratio.
Let’s look at the dramatic effect that other debt has on the TDS ratio calculation by using an example. A couple with a combined income of $100,000 wants to buy a home and need a mortgage. They have a down payment of $30,000. They have $5,000 outstanding on credit cards and a car loan payment of $800 per month. Factoring in these debt payments and using today’s interest rates and a 25 year amortization, the couple qualifies for a mortgage of approximately $370,500. Now let’s assume they have paid off just their car loan before getting a mortgage. The couple now qualifies for a mortgage of $414,900, or $44,400 more! To further understand your own specific situation, most banks have excellent calculators on their websites to help you understand how paying off your debts can improve your situation. It should be noted that in the most extreme situations, your debt load can prevent you from qualifying for a mortgage at all!
If you need help, there are many different ways to make it easier to pay down your debt including consolidating your various loans and credit card balances into a single loan with a set repayment schedule. By consolidating debt, you could save on interest costs, you will have just one payment to make, and you may find it easier to pay off your debt more quickly. A debt consolidation loan can also reduce your monthly payments, thus helping you qualify for a mortgage.
Do your own basic TDS calculations then contact a mortgage specialist and get pre-approved for your mortgage. The application process will require you to provide details on employment, income, assets, down payment and debts. You're under no obligation when you're pre-approved, but you should still feel comfortable with the amount and terms of your pre-approved mortgage. That's why it's vital that you review all your debts and personal expenses and have some idea of your future expenses before you talk with a mortgage specialist about pre-approval. When you've got a pre-approved mortgage, a lender has made an actual commitment (subject to conditions such as a property valuation) to lend you money. Mortgage pre-approval should be your first step when you're seriously looking for a home to buy.
Author: Kevin Lutz
Regional Manager, RBC Residential Mortgages
Tony Marchigiano | Mortgage Specialist - Mortgage Sales BC Region, RBC Royal Bank | Royal Bank of Canada | T. 604-505-7109 | F. 778-737-0054
Follow me on Twitter: http://twitter.com/RBCTMarchigiano