With interest rates at historic lows, now is a great time to purchase a home, but it could also be a potentially dangerous situation. Stretching your mortgage debt service ratios beyond what is comfortable is tempting, but the risk of doing so will depend on mortgage interest rates. Canadians, in general, have mortgage debt service ratios that are well into the comfort zone, but for some consumers, it is a different story.
Mortgage Debt Service Ratios in Canada: The National Picture
We have seen a sharp increase in mortgage lending due to lower interest rates over the last few years. As a result, mortgage credit has been growing at 5.5% per year on average, with mortgage debt service ratios in Canada remaining somewhat stable. The mortgage debt service ratio is the proportion of household income dedicated to mortgage payments or rent of a rental property. Banks want to ensure that mortgage borrowers can afford their mortgage payments before approving the loan.
The mortgage debt service ratio is a mortgage regulation. The government uses it to determine Canada’s maximum mortgage amount and mortgage qualification. It also plays a role when considering housing affordability in Canada for would-be home buyers, especially in today’s low mortgage interest rate environment.
Mortgage Debt Service Ratios: The Details
A couple of years ago, TD Bank researched mortgage debt service ratios in Canada. They found that most Canadians had mortgage debt service ratios within comfortable limits; however, there were some exceptions.
For instance, the Bank said that many homeowners take on too much money relative to their income levels. That could be problematic if interest rates increase significantly over the next few years and mortgage payments become more and more un-affordable for consumers.
Gross Household Income vs Net Household Income
Banks consider total gross household income when determining mortgage affordability in Canada. That is because mortgage payments are a significant portion of an individual’s monthly spending.
Mortgage lenders use the net household income figure for mortgage affordability, but these two figures can be very different. Gross household income, for instance, does not include deductions such as RRSP contributions, charitable donations and other write-offs. For this reason, it may not accurately reflect what consumers spend at the end of the year on expenses like mortgage debt service ratios.
The minimum down payment required by various Canadian Provinces is another crucial factor in mortgage affordability. It determines how much money you will need before shopping for your new home or condo.
GDS Ratio and TDS Ratio
GDS (Gross Debt Service) and TDS (Total Debt Service) ratios are mortgage loan affordability metrics that lenders use to determine whether or not mortgage interest rates will be manageable for mortgage borrowers. In general, mortgage lenders want to know that your minimum monthly payments on housing costs, including mortgage principal and interest, property taxes and heating costs combined, won’t exceed 32% of household income. The Bank of Canada has also emphasized that the maximum affordable mortgage debt service ratio should be 40% when gross income is under $100,000.
Your Credit Score Will Affect Mortgage Rates
Your mortgage affordability or qualification will depend on your credit score and mortgage rates. As mortgage interest rates increase, your monthly mortgage payments will also increase. That means it’s even more critical to know Canada’s mortgage rules before starting your home or condo shopping process.
Down Payments in Canada
Down mortgage payment of at least 20% is typically what mortgage lenders require in Canada. However, some mortgage down payment assistance programs are available for first-time home buyers. Moreover, suppose you can’t afford the “mortgage debt service ratio” rule. In that case, your mortgage lender may still approve your mortgage loan request if you have vital compensating factors, such as excellent credit history and a long employment record.
It’s also important to note that mortgage guidelines vary across Canada. Therefore, it’s essential to know your province’s minimum mortgage down payment requirements before starting your home or condo shopping process. In addition, while interest rates play a role in housing affordability in Canada, not all consumers will qualify for the same mortgage interest rates or get approved for loans with the same terms and conditions.
How to Make Your Mortgage More Affordable
A mortgage calculator helps determine your monthly payment based on the purchase price of the home you are interested in. In addition, this mortgage affordability calculator will ask about your gross household income and down payment, mortgage interest rate and amortization period to determine how much money you need to borrow.
Increased borrowing power may allow you to buy a bigger home or condo. However, it may also mean that mortgage rates in Canada become unaffordable for mortgage borrowers who aren’t prepared to manage their mortgage payments at higher interest rates. Therefore, it’s essential to consider all possible outcomes before getting into “affordable” mortgage debt, which could negatively affect many aspects of your financial well-being in the long term.
Your net household income helps calculate mortgage affordability, including the mortgage debt service ratio; however, other factors are essential. For example, your net income is $5,000 per month, but you spend $3,000 on mortgage payments and another $2,000 to cover property taxes and heating costs.
These additional expenses might limit your true mortgage affordability. Calculating the TDSR helps consumers understand their maximum mortgage amount based on their monthly housing expenses before making mortgage shopping calculations.
Your credit score will also play an essential role in determining the mortgage interest rate you qualify for as well as whether or not you can get approved for a mortgage loan at all. The higher your credit score is in Canada, the more likely you will qualify for mortgage debt at a better interest rate. A mortgage qualification letter from your mortgage lender is required in Canada before homeowners can close on a mortgage loan.
Mortgage rates in Canada affect mortgage affordability. Your mortgage payment is based on the total amount of mortgage that you need to borrow and the mortgage interest rate charged by your lender. To determine mortgage qualification and how much you can afford, mortgage lenders will also ask about your gross household income and down payment.
It’s important to note that different mortgage interest rates apply based on how many compensating factors a consumer has (such as excellent credit history and a long employment record). Still, education on mortgage debt service ratios is essential to understanding how much mortgage you can afford.
We are available to walk you through all mortgage processes and help you pick and acquire the most suitable loan.
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