With the new mortgage stress test rules now affecting all Canadian homebuyers no matter how large their down payment is, there’s a lot of frustration about mortgage qualification in Canada. Some people that can actually afford the mortgage they’re applying for might be rejected because they fail the stress test. This could lead them to going to an alternative lender with a higher interest rate, or not being able to get in to the real estate market altogether.
One of the ways that the stress test affects homebuyers is through GDS/TDS ratios. Qualifying at a higher mortgage rate for the same mortgage amount is a lot harder because it can add hundreds of dollars to your monthly payments, even though you don’t actually have to pay that much.
When homebuying, it’s best to get a good idea of your home affordability before going shopping. You may think that you can qualify for a lot more than you really would, which can throw a wrench into your plans. The best way to calculate your affordability is to know the max GDS/TDS in Canada.
GDS stands for Gross Debt Service ratio, and is the amount your housing costs per month divided by your gross (pre-tax) monthly income. A good GDS is around 35% or less, while the max GDS in Canada is 39%.
The monthly housing costs used to determine GDS are mortgage payments, property taxes, and heating costs. If you are buying a condo, you’ll also have to include 50 per cent of the condo fees. You then divide that number by your monthly income and multiply it by 100.
Bob makes $60,000/year and is looking to buy a semi-detached home in Orangeville. He has great credit and a down payment of $25,000. Because of the minimum down payment in Canada rules, he can’t purchase a house that’s worth more than $500,000, as he would only have 5% down.
He decides his budget is $350,000 based on the houses that some of his friends have bought in the area. But would he qualify?
With his great credit, Bob is likely to get the best mortgage rates in Canada. For a 5-year fixed rate, that’s currently 3.45%.
$25,000 down on a $350,000 home is 7.14%, so he’ll have to pay CMHC insurance premiums. A down payment of less than 10% gives a CMHC premiums of 4% of the purchase price, so the total mortgage amount Bob needs is $329,000.
At a rate of 3.45%, the monthly mortgage payments on a $329,000 mortgage would be $1,638. Property taxes in Orangeville are 1.384002% of the property value, so that would be $4,884 per year, or $403 per month. We’ll estimate heating costs at $100 per month. That brings the total monthly cost of buying that home to $2,141.
Bob’s monthly salary is $5,000. His GDS is:
$2,141 ÷ $5,000 × 100 = 42.8%
Bob won’t be able to qualify for this mortgage!
Mark and Susan are thinking of buying the exact same home in Orangeville. They both have excellent credit as well and together earn $80,000 a year.
With everything the same, the GDS calculation looks like this:
$2,141 ÷ $6,666 × 100 = 32.1%
Which is well within the acceptable GDS limit!
TDS stands for Total Debt Service and takes into account the cost of your housing and all your monthly debt payments. Because TDS will always be the same or higher than GDS, the acceptable ratio is higher as well. Lenders like to see no more than 40% TDS, but the maximum TDS in Canada is 44%.
Let’s see the TDS ratios of Bob, Mark, and Susan.
Mark and Susan both went to university to get degrees. They each pay $150/month in student loans. They also share a vehicle they purchased a few years ago which costs $250/month.
Their combined monthly debt payments are $550, which is then added to the housing costs to determine TDS.
[$2,141 (housing costs) + ($150 × 2)(student loans) + $250 (car payment)] ÷ $6,666 × 100 = 40.4%
40.4% is a bit higher than the industry standard of 40%, but still under the maximum TDS of 44%. With their good credit, they should still qualify for a mortgage.
Bob went to work straight out of high school, so he has no student loans. He paid off his car last year and always makes sure to pay off his credit cards every month. Bob’s TDS is
[$2,141 (housing costs) + $0 (debt payments)] ÷ $5,000 × 100 = 42.8%
Even though Bob’s TDS is under the maximum value because he has no debt, his GDS is still too high. Both GDS and TDS must be under the maximum to get approved for a mortgage.
If your credit is good but your ratios are too high to get a mortgage, you should see what you can do to lower them.
Broadly speaking, there are two ways to improve your ratios: make more money, or spend less money. But there are multiple ways of doing either.
Obviously getting a raise at work would mean you can afford a larger budget. But getting a raise isn’t exactly easy. Instead of focusing on your work, you can raise money for your home purchase from other places.
Something to consider when buying a home is whether you qualify as a first-time homebuyer for any first-time homebuyer programs, like the Home Buyers’ Plan (HBP). The HBP allows you to withdraw up to $25,000 tax-free from your RRSP to use towards a down payment on a house. If you have a partner, they can withdraw up to $25,000 from theirs as well, bringing the total to $50,000.
Withdrawing from your RRSP for the HBP lets you access the money that’s locked up in your RRSPs, if you have any. Normally there are very steep tax implications for withdrawing early, which you avoid completely so long as you repay the amount you took out within 15 years.
If your family is in a position to help, you could also get a gifted down payment. Parents helping their children is becoming more common as house prices have been rising steadily for years, only slowing down recently. Gifted down payments will reduce your mortgage amount, therefore reducing the CMHC premiums and monthly payments as well.
Finally you can consider borrowing a portion of your down payment. The rules are very strict about how you can use borrowed funds as a down payment for a home, but you can lower your CMHC premiums and sometimes even get a better mortgage rate.
The easiest way to spend less money on a home is to lower your budget, but depending on your city it can be hard or impossible. Perhaps the houses that are affordable in your city require thousands of dollars in renovations, or are in unsafe neighbourhoods, or are too far from work, or just aren’t big enough for your family.
Other ways you can spend less money are:
Whether you borrow money for your down payment, get help from your family, or just wait longer and save, increasing your down payment will always lead to a lower mortgage payment.
Sometimes your mortgage rate could be the deciding factor in your mortgage. If you have lower credit, then you’d have to pay a higher rate, which can lead to your ratios being thrown off. Improving your credit score or shopping around for the best rate can save you thousands of dollars, and might even let you qualify if you wouldn’t otherwise.
Your GDS and TDS ratios don’t tell the full story of your financial situation. If you were denied a mortgage because of your ratios, be sure to speak to a mortgage broker like RateShop.ca. More often than not, a mortgage broker can find ways to qualify you for a mortgage even if nothing has changed in your situation.