Mortgage lenders look at several important numbers when determining home buyers affordability. This blog post examines these formulas and their inputs.
Gross Debt Servicing Ratio (GDSR or GDS):
Here is THE formula lenders use to calculate your Mortgage affordability. When you understand how much you are eligible to borrow AND you know your down payment amount, you can determine your home purchase price.
With me?
Here are the terms of the formula first:
P = Principal portion of your Mortgage payment.
I = Interest portion of your Mortgage payment.
T = Tax of your new home.
H = Heating cost of your new home.
½ C = ½ any condo or homeowner association fees.
Gross Income = Your BEFORE tax earnings.
The GDS Formula:
P + I + T + H + ½ C
______________________
Gross Income
This formula creates what is called the “gross debt service ratio”. Also referred to as GDS or GDSR.
When I input my numbers into this formula, I am left with a ratio. This ratio tells the lenders how much of my BEFORE tax income is going towards paying for my basic home living expenses.
To feel comfortable lending hundreds of thousands of dollars, the maximum this ratio is allowed to be is 0.32 or 32%.
Said another way …up to 32% of your gross income is eligible to go towards your Mortgage payment, tax, heat and ½ condo fees (if applicable) with a reasonable chance of Mortgage approval.
Total Debt Servicing Ratio (TDSR or TDS)
Another ratio the lenders look at when qualifying me for a Mortgage is the “total debt-servicing ratio” Also referred to as TDS or TDSR.
This is the EXACT same ratio as the GDS but also calculates how much other debt I have.
Other Debt = any outstanding revolving or fixed payment debt I may have.
Revolving debt is when I pay down the balance of my debt, I am able to re-borrow the money again. For example, my credit cards or lines of credit are revolving debt.
When qualifying for a Mortgage the lenders use 3% of any outstanding revolving debt payment as a liability on my Mortgage application.
For example, if my total credit card debt were $2,500 I would use a 3% payment of $75/month as a liability payment on my Mortgage application ($2,500 * 0.03 = $75).
Installment loan debt is a set/fixed repayment schedule. When the balance of my installment loan debt is repaid, I do not automatically re-borrow that money. For any installment loan debt, the monthly principle and interest payment is used for Mortgage qualifying.
For example, if I have a car loan payment or student loan payment, both of which are fixed payment (frequency does not matter), I use that actual payment as a liability in Mortgage qualifying.
Now, the TDS formula looks like this:
The TDS Formula:
P + I + T + H + ½ C + Other Debt
______________________
Gross Income
When I crunch the numbers from this formula I am given a ratio. The maximum ratio I am allowed to have is 0.42 or 42%.
Said another way, a maximum of 42% of my gross income is eligible to pay for my basic home and Mortgage expenses AND service all of my other debt.
You might notice these qualifying ratios DO NOT factor in other monthly expenses I typically incur, that are: gas to fuel my vehicle, and to support the current lifestyle I decide to live (eating out, vacations, saving for retirement and or home improvements etc).
I think the list of additional expenses associated with home ownership is extensive (relative to renting). I help all of my clients understand the reality of homeownership by helping them understand their current lifestyle and what might need to change (if anything) as a new homeowner.
I think understanding these qualifying ratios is important because it helps you understand the rules of the “game” we are playing together. Imagine playing soccer, baseball or football without understanding the rules.
Mortgage lenders lay out the framework or “ball park” that Mortgage qualifying is built around. If my affordability is higher than I am comfortable purchasing, then lowering my purchase price and qualifying ratios is a good thing.
If I find my affordability is lower than what I expected, now I can plan and make different decisions to help increase my affordability. When I am aware, I can make changes to produce an outcome I prefer.
If you would you like to quickly find out what your qualifying ratios are, input your numbers into these formulas. Note, accuracy of inputs will determine accuracy of the qualifying outputs. For a no obligation, accurate assessment of your affordability, connect with me here.
Talk soon,
Chad Moore
