September 12, 2013
Debt ratio is a calculation used by lenders to determine whether you have the ability to make your monthly mortgage payments. This calculation is very important as it also determines how much money you can comfortably borrow when buying a home. But since the global economic crisis of 2008, the Canadian Mortgage and Housing Corporation (CMHC) has imposed stricter debt ratio calculations.
If you're a potential home buyer who is pushing the boundaries of qualification, you may have a tougher time obtaining a mortgage. Or, you may be able to obtain one– but not in your desired amount.
Last month, the CMHC issued new guidelines for calculating debt ratio. Although these new rules will take effect on CMHC-insured mortgages on December 31, 2013, many lenders have already started to apply them.
Here's a breakdown of the new guidelines and some clarity on the terms most often-used when applying for a loan.
For variable income: Mortgage amount cannot exceed the average income of the past two years. Variable income refers to such income as bonuses, seasonal employment, tips, or investment income.
For rental income: Some borrowers earn additional income through "investment properties" by collecting rent from its tenants. A lender must calculate the principal, interest, property taxes and heat (commonly abbreviated together as PITH) on these properties. These amounts must either be: deducted from gross rent revenue to determine net rental income; or included in "other debt obligations" when the Total Debt Service (TDS) ratio is being calculated.
For guarantor income: A guarantor is the person who will make payments on a mortgage should the original borrower default. Under the new guidelines, a guarantor's income cannot be used in debt ratio calculations — unless he/she will occupy the home and is the spouse/common-law partner of the borrower.
Unsecured credit lines/credit cards: No less than 3% of the outstanding balance must be included in monthly debt payments.
Heating costs: Under these new guidelines, lenders must now obtain the actual heating cost records of a property. If no records are available (for example, the property is brand new) then heating expenses must be estimated. These estimates must be reasonable and take into account property size, location and/or type of heating system.
The CMHC has changed the guidelines for debt ratios in response to the federal government's tightening of overall mortgage rules. Finance Minister Jim Flaherty has warned that Canadian households are carrying massive debt loads that are becoming increasingly unmanageable. Much of this debt burden was triggered by low-interest mortgages which encouraged spending as Canada tried to recover from a global economic downturn.
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