How can I know the amount that I could borrow for a mortgage on a house?
Let us look at income qualification required by lending institutions for an owner-occupied property.
In general, the amount of gross family income will determine the amount that can be borrowed on a mortgage for an owner-occupied home. Once the mortgage figure has been determined, it can be added to the actual cash down payment available (not including cash for legal costs and the usual disbursements) to determine the amount the borrower can afford to pay for his home.
Institutional lenders refer to their qualification method as the GROSS DEBT SERVICE RATIO (G.D.S.R.). This figure is the ratio between the amount required for the PRINCIPAL, INTEREST, TAXES AND HEAT (P.I.T.H.) and the gross family income.
The majority of lenders will permit up to 32% of the gross family income to be applied to P.I.T.H but in the mortgage industry the 32% figure is also known as the "macaroni-three-times-a-week" syndrome. If these calculations are applied to net income, the ratio for the average wage earner will be 40% to 50% of net income and may put a burden on their lifestyle and require some financial sacrifice during the early stages of the mortgage.
On the other hand, the mortgage payments will remain constant for the term of the loan, and if a borrower is permanently employed and expects a modest salary increase every year, the G.D.S.R. will automatically decrease, making the financial commitment a lot easier as the years go by. Another aspect to consider is the possible increase value of the property. Chances are that over the term of the mortgage the payments required will be almost equal to or lesser than the rent for equivalent facilities, but the homeowner is increasing his own equity rather than that of his landlord.
One should keep in mind that not every institution will accept a gross debt service ratio of up to 32%. Some lenders will only go to a maximum of 30%, 28% or even 27%. Before applying for a mortgage loan, the borrower should ascertain the lender's guidelines in this regard.
Once the G.D.S.R. has been considered, the lender will look at the TOTAL DEBT SERVICE RATIO or T.D.S.R.. This figure is made up of the G.D.S.R. plus any amounts required for other monthly obligations such as car loans, credit card payments, alimony, etc. As a rule of thumb, lenders will allow a maximum T.D.S.R. of 40% of gross annual income.
As an example, let's consider a homebuyer with an annual income of $50,000. If the mortgage lenders accepts a G.D.S.R. of 32% and a T.D.S.R. of 40%, the maximum allowable total of principal, interest, taxes and heat would be $16,000 per annum, with an additional $5,000 allowed for other loan payments. Supposing that the taxes and heat amount to $2,000 per annum, leaves $14,000 or $1,166.00 per month for principal and interest. On a five year term mortgage at 5.50% (compounded semi-annually) amortized over 25 years, the homebuyer would qualify for approximately $190,000. Therefore, if he had a cash down payment of $20,000, he could afford to purchase a property priced at $210,000.
The homebuyer should always ensure that sufficient funds have been set aside for legal expenses and disbursements, moving costs and every other necessity required for the new home, so that he will feel at ease with the monthly obligations of his home financing.
Guy R. Gauthier