What? I make $75,000 and I don’t qualify for a home in the Fraser Valley?
That’s typical of the kind of disbelief I often hear from people inquiring about qualifying for a property purchase through rent 2 own.
And the answer is: No! $75,000 will get you an apartment, perhaps a townhouse, but not a single family home. Unless you have a massive down payment.
In the first of this series we identified three questions the banks will examine when they consider whether to approve you for a mortgage. The next three parts looked deeper into the question of how they assess your track record of responsibility (aka, credit score and report).
Now we look at the second question: Can the applicant afford the monthly payback schedule?
As I mentioned in part one of this series, it is ultimately not what you think you can afford for a mortgage payment, but whether you fit into the formula the lenders follow. That formula is imposed by the mortgage insurers–all mortgages greater than 80% must be insured—and is prescribed by the federal government through CMHC, the dominant mortgage insurer.
The formula simply states that your gross debt service ratio (GDS) must not exceed 35% (or 39%) of your gross monthly income. (The reason there are two numbers is that CMHC lowered the number from 39 to 35 last summer but the two smaller, private mortgage insurers did not follow suit—yet).
GDS is your monthly housing costs, calculated as the sum of your mortgage payment–principal and interest, property taxes and an amount for “heat/utilities”. For every potential purchase, these sums are calculated. Meanwhile, your gross monthly income is determined and the ceiling established by applying the ratio. If, for example, you make an annual income of $75,000, then your monthly gross income is $6250. Thirty-five percent of that is $2188. If GDS doesn’t exceed that amount, you qualify.
With today’s low interest rates, one would calculate that that should cover a mortgage of about $450,000.
But, wait! A couple of years ago, the government implemented a “Stress Test,” to protect people from getting into trouble should interest rates increase. It simply requires that you qualify for a rate two percentage points higher than the rate you will actually get, or a rate of 4.79%, whichever is higher. With that standard in effect, that monthly income will only qualify you for about a $325,000 mortgage.
In the Fraser Valley, with a 10% down payment, that will get you a condo (apartment) or a very modest townhouse but not a single family home.
But wait (again)! There may be another limiting condition. What if you have other debts, like a car payment, outstanding credit card debt or a student loan? Of course, they’ve thought of that, too, so there is a second restrictive formula to apply.
Your Total Debt Service ratio (TDS) must not exceed 42% (or 44%) of your gross monthly income. (Again the number was reduced from 44% to 42% by CMHC, but the private insurers have not yet followed). TDS is your GDS plus all other debts combined. This leaves you room for 5% (or 7%) of your gross monthly income for all other debts besides your housing costs. If your other debts exceed that ratio, then your GDS limit will go down accordingly.
Using the above example, if you have a car payment of $500 per month and outstanding credit card debt of $10,000, then your GDS will be reduced from 35% to about 30%, and your maximum mortgage amount from $325,000 to about $290,000
Add your down payment to these numbers, and that will determine what you can afford for a property purchase.
These complicated calculations can be reduced to a simple “rule of thumb” multiplier. At Fraser Valley Rent 2 Own we use a multiplier of 4.5 times your gross annual income as an approximate maximum value of property that you can afford (assuming a 90% mortgage, and that you don’t have significant other debts that infringe). It’s a little conservative, but allows some room for risk aversion, since we are qualifying you now for a purchase at the end of the term, perhaps three years away.
At Fraser Valley Rent 2 Own, we can “buy you time” to meet mortgage qualification rules. But ultimately, at the end of the term, you need to qualify under those rules. Therefore, we can’t skirt the above standards.
With the escalating house prices all over BC (and especially in the Fraser Valley), rising much faster than incomes, it’s increasingly tough to qualify for your dream home purchase. But it’s still worth “getting into the market” as soon as you can, even if that means something more modest, then moving up at an appropriate future time.
Bottom line: multiply your gross annual income by 4.5 times and you’ll come pretty close to what you can afford for a home purchase.