You have to know how much money you are comfortable spending each month on your new home. When you add up the mortgage payment, the property taxes, utilities, condo fees and home maintenance at what point do you scream “that’s enough!”
Mortgage lenders will assess affordability for you too – they follow precise measuring guidelines to determine how much of a mortgage you are qualified to carry. Their method is pure arithmetic – they remove the emotion from the calculation. They calculate two very important ratios.
- Your GDSR (Gross Debt Service Ratio) This is the the sum of your mortgage, taxes. heating bill and half of your condo fees, if applicable, as a percentage of your gross income.
- Your TDSR (Total Debt Service Ratio) Then they also factor in all your other monthly debt obligations (credit cards, student loans, car payments etc.) and figure out the grand total as a percentage of your gross income.
Gross Debt Service Ratio (GDSR)
This refers to principal, interest, property taxes, and heating costs – in short, the costs of owning your home. If applicable, fifty percent of condo fees are added to this equation. To figure out our GDSR, we will take the household’s gross income (how much money you make from all income sources before any taxes are taken off) and divide these home ownership costs by that number.
Most lenders want your GDSR to be at or under 39%. For example, if you are looking to get a $1,000-per month mortgage payment, and your heating bill is $1,800 per year, while you pay $3,000 in taxes, then your cost (for mortgage purposes) for the year is $16,800.
You would have to earn at least $52,500 per year in order for lenders to consider you for this hypothetical home under most circumstances.
Total Debt Service Ratio (TDSR)
The second rule of thumb is your entire monthly debt load should not be more than 44% of your gross monthly income.
Basically, the lender will take the number you used when you figured out your annual housing costs (PITH) and add any other debt that you have. This includes any car loans, credit card debt, alimony, child support, and any other loans.
Just Because You Can, Doesn’t Mean You Should
If you spend 39% of your gross income on housing costs, you will have to sacrifice in other areas in your life. It’s just basic math.
You likely won’t have much breathing room to throw at worthwhile goals like retirement savings, RESP contributions, vacations, or small luxuries. (This isn’t even accounting for higher interest rates or unexpected job loss.)
Give yourself some breathing room and don’t tempt yourself by shopping for homes well outside of your true affordability range.
Get pre-approved long before you actually think you might want to buy a house. Start talking to your preferred lender or mortgage broker/agent early in the process. Pre-approved means you’re conditionally approved for a mortgage – up to a certain limit – in advance of actually buying a house.
It speeds up the process substantially once you find the home you’ve always wanted. Basically, the idea is the lender gets all of your paperwork in order and assesses your risk level in advance. That way, nothing is rushed when you start making offers.
As part of the pre-approval process, most lenders will want to do a hard inquiry of your credit score. An experienced mortgage professional can review your personal copy of your credit report, together with all the documents a lender is going to ask for, and will be able to offer a very strong opinion on what you will qualify for.
Much of the material in this section was originally written by Kyle Prevost, in his ebook buying a house in Canada.