By now you will have probably heard that the Finance Minister has made drastic changes to mortgage lending rules making it tougher to qualify for a mortgage. For Canadians with less than a 20% down payment, their purchasing power has been dramatically reduced. So what can you do if you want to purchase a home in the next few years? Below are five main points you will want to consider if home ownership is one of your financial goals.
First, however, let’s clarify the role of debt servicing in the mortgage approval process. There are two types of debt servicing ratios that lenders look at. The first is Gross Debt Servicing (GDS) and it includes the costs associated with housing – mortgage principal and interest payment, property taxes and heat. The second ratio is Total Debt Servicing (TDS) which includes all costs in the GDS plus all other outstanding debt. These ratios need to be below 39% for GDS and 44% for TDS. So let’s look at what you can do to qualify within these ratios.
1. Pay Down Debt. Balances on unsecured debt, such as credit cards and unsecured lines of credit affect your TDS ratio. Even if the GDS is in line, if your TDS is high, your maximum mortgage amount will be limited. All unsecured debt must be calculated at a 3% payment per month regardless of the actual payment required. For example, a $10,000 credit card balance equates to a $300 per month payment for debt servicing. High balances combined with other types of debt (i.e. car payments) will affect the maximum mortgage amount so pay them down.
2. Hold Off on that New Car. We all love that new car smell and dealerships make it very easy to purchase a new car. However, that car payment may make the difference between qualifying for a mortgage or not. If home ownership is a goal for you, then you need to understand how that car payment will affect your debt servicing ratios. Like unsecured debt, that car payment is calculated in your TDS.
3. Manage Your Credit as if it is Your Most Valuable Possession. Now, more than ever, good credit will be a key to home ownership. As the landscape of the mortgage world continues to change, credit will become a main focus of lenders when considering mortgage applications. Always make your payments on time, keep balances below 70% of your limit and maintain at least two types of credit with a two year history.
4. Save, Save, Save. Start saving now for that down payment. As mortgage guidelines tighten, the larger the down payment you have saved, the more options available to you. Gifted down payments from immediate family can also be considered as part of your down payment.
5. Start Claiming Income on Your Tax Returns. This sounds contrary to what most people would think as we all strive to pay less taxes. However, over the last several years lenders have been requiring proof of income based on your tax returns. The higher the income on the tax returns, the more income that can be used to qualify you for a mortgage. Income such as self-employed income, tips, overtime, etc. require a two year average in order to be used. If you want to purchase a home in the next few years, you may want to start claiming all income earned to maximize the mortgage amount you qualify for. Guidelines around self-employed income have been tightening up for a few years so there is no guarantee the programs available now will be available in the future.
As the government continues to tighten mortgage lending rules, it is more important than ever to ensure you work with a mortgage professional you trust who can guide you towards home ownership.