Over the past few years we have seen massive changes in the mortgage industry. Starting with reducing maximum amortizations from 40 years to 35, 30 and eventually 25; to the discontinuation of zero down mortgages. In my opinion, these changes brought stabilityto Canadian mortgage lending that will help to protect our economy from what happened in the US in 2007.
The latest changes are to do with credit card debt and debt ratio calculations that we in the mortgage industry must comply with. When getting pre-approved for a mortgage, your gross provable income
is calculated as a ratio against your debt in 2 ways:
- GDS or gross debt service ratio is your income against your proposed new mortgage payment, property taxes, condo fees (if any) and a $75.00 per month heat component.
- TDS or total debt service ratio is your income against all of the above plus any other monthly debt obligations such as loans and credit cards.
The mortgage lenders and insurers have set the guidelines for these ratios to be a maximum of 35% GDS and 42% TDS (higher ratios allowed for clients with excellent credit).
Household income of $65,000.00.
Mortgage requested of $320,000.00 with property taxes of $3500.00/yr. plus $75.00/mo. for heat.
With no other monthly payments on loans or credit cards the debt ratios sit at 34% TDS and 34% GDS which is within the guidelines and would most definitely be approved.
With credit cards carrying a total balance of $25,000.00, most of the time the credit report would show a required payment of 1% of the balance so in this scenario would be $250.00 per month. This would bring the debt ratios to 34% GDS and 39% TDS which again is allowable and would more than likely be approved.
Changes have come into effect recently that has a huge impact on how scenario B is calculated. Now, no matter what the credit report says is the required payment, lenders are required to use 3% of the balance owning. This would change the payment from $250.00 to $750.00 per month. The debt ratios are now at 34% GDS and 48% TDS which is well out of line and would not be approved.
When looking at these scenarios logically, using a 1% payment on a credit card when taking on a mortgage sets the client on a path to carrying this debt for a very long period of time. Using 3% of the balance does not ensure that this debt will be paid, but it gives the borrower the ability to do so.