How Much Debt is Too Much for a Mortgage
How you as a consumer can evaluate your financial situation
Most adults in Canada have some amount of debt. In fact, as of 2017 the average Canadian owes over $8500 in consumer debt, which includes all debt that is not part of a mortgage. So, assuming you - like 54% of Canadians in the referenced poll - hold some amount of debt, you might be wondering just how much is too much for a mortgage. The short answer: it depends. We always recommend working with a member of the Essential Mortgage team when applying for a mortgage, as this is something one of our brokers can help you figure out. This is because mortgage lenders use what are called your “total debt service ratio” (TDS) and “gross debt service ratio” (GDS), which we touched on in our previous blog post here. In short, they’re the ratio of your income to your expenses.
To get a bit more detailed, your gross debt service ratio is your expected monthly expenses of housing - the principal and interest components of a mortgage payment, property taxes, heating, and 50% of condo/strata fees - versus your income. For example, if you make $60,000.00 per year, that’s $5,000.00 per month. If your housing expenses consist of a projected $1,500.00 mortgage payment, $150.00 in property taxes, and $100.00 in heating every month, that would total $1,750.00. That then presented as a percentage of your income (1,750/5,000x100) is 35% - which is good, because lenders generally want to see a gross debt service of 35% at most.
Then, lenders will add in your other monthly debt payments - such as a car loan and credit card payments - to calculate your total debt service. Assuming that you pay $200 a month for your car financing, and another $100 a month in credit card payments, that would bring your total monthly bills to $2,050 per month. As a percentage of your income (2,050/5,000x100) that brings your total debt service to 41%. This is a good result as well, as lenders generally don’t want to see your total debt service being higher than 42%.
So to answer the original question, “how much debt is too much debt for a mortgage?” The short answer was “it depends.” The long answer is more complex. The 35% GDS and 42% TDS are industry standards, but a mortgage broker can work with a lender to get you an exception in specific circumstances, such as if you have excellent credit, or are currently paying a significant portion of your income in rent, and have been for some time. If you want to know what you can currently afford however, you can calculate what your total debt service would be with a given mortgage payment. For this, a mortgage calculator such as the one found here is an excellent tool.
Calculate what the mortgage payment would be given an interest rate - such as the current prime rate, 3.95%* - and either a 25 or 30 year amortization, and see what your monthly bills would total in comparison to your income. For example, assuming a $400,000.00 property with a 20% down payment, you would need a $320,000.00 mortgage. With a 3.95% interest rate and 25 year amortization, the monthly mortgage payment would total $1,680.00. Taking the monthly income and bills from the previous example, this does present an issue as the monthly payments are $180.00 higher. This could be solved by changing the amortization to 30 years, as 30 year amortization brings the monthly payment down to $1,519.00. This means the monthly bills would be $2,069, compared to the monthly income of $5,000, which results in a TDS ratio of 41.38% (2,069/5,000x100), which is still within acceptable ranges for traditional lenders.
If you’re not sure whether or not you have too much debt for a mortgage, you can always consult a member of the Essential Mortgage team. They will analyze your financial situation, including your assets and liabilities, and give you an idea of what amount of financing you will qualify for. They can also give you advice on what debts you’ll be able to pay down before the mortgage funds to meet the lender’s requirements for your gross debt service and total debt service.
*This is the prime rate as of March 19, 2019.
All information herein subject to change and all offers mentioned are subject to change and OAC.
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