By Nick Holloway 

There has been a lot of talk recently about the new qualification rules in effect which are reducing mortgage affordability by around 20%. The effects of these new rules has largely affected first time home-buyers the most while they are looking to enter the housing market.

How do lenders determine a borrower’s qualification?

Let’s start with a brief overview of the qualifying ratios, which are worked out as a percentage of the applicant’s gross income. Firstly, there is the Gross Debt Ratio (GDR) which accounts for mortgage payment, property taxes and heat. Secondly, the Total Debt Ratio (TDS), which accounts for the same as GDR, but also includes all other debts. Note the actual mortgage payment used in these calculations is determined by the qualifying rate, currently 5.34% or 2% above offered rate (whichever is higher), and not by your actual mortgage payment. As an example of the ratios lenders typically use for determining affordability, we can look to current insurer guidelines in Canada which state that if a borrower has a down payment of less than 20%, the highest these ratios are allowed to go is 39% for the GDR and 44% for the TDS.

OK Nick, is there anything I can do to improve my TDS ratios?

Glad you asked, yes there is! To focus on the TDS, we have to know the impact of each kind of debt in the calculations. Currently with credit card debt, it’s considered a revolving credit line and a monthly payment of 3% of the overall balance is assumed. As an example, if your credit card balance is $2,000, the lenders will assume a $60 monthly payment. With a car or auto loan, the balance is not used in the same way but the monthly payment is looked at instead. For example, let’s say your car loan has a remaining balance of $2,000, but you will continue to pay $600 each month until this loan is paid off, so it’s the $600 payment that will be used in the calculation.

So as we have in the above example for the car payment, we see the same amount of debt has a ten-fold increase in respect of affordability calculations. To put this in terms of how much less affordability this car payment makes to what you can qualify for in dollar terms, we need to look back to the qualifying rate. If we use the 5.34% rate for this example, with a 25 year amortization on say a $100,000 mortgage, then we have a qualifying mortgage payment which equals $601.11. Now we can determine that the car loan under the TDS ratio is reducing the borrower’s affordability by roughly $100,000, which might make the difference between qualifying or not for the property you are looking at. If this is the case, my suggestion would be to see if you can settle the car loan early which will decrease the TDS and potentially bring the ratios in-line with the constraint.

If you have any questions and want to discuss your mortgage or this strategy in more details, I would be more than happy to help.