It’s important to know how much home you can afford before you start applying for a mortgage. This can help limit your search to realistic options, and avoid disappointment when you find a house and then apply for a home mortgage. So, it’s essential to understand how much you can afford.
You may think that any amount that fits within your monthly budget is comfortable and sustainable, but your mortgage lender may consider many different factors along with it. To determine what you can truly afford, there are some guidelines that mortgage lenders insist you abide by and they can ensure that you don’t get in over your head with your home purchase.
How Mortgage Debt Ratios Determine Affordability
You might think that if you make $5,000 per month than $2,500 per month to carry your mortgage is quite affordable but it’s not quite as simple as that to a mortgage lender. They look at few essential debt ratios to ensure that you’re taking on a mortgage well within your earnings with consideration to your other debts and expenses.
Gross Debt Service Ratio (GDS)
The Gross Debt Service ratio is the percentage of gross annual income required to cover payments associated with home mortgages. It requires that your home loan requirement is not higher than a fixed percentage of your household income, which can vary by program and lender.
The way the GDS is determined is by calculating the monthly mortgage amount + property taxes + condo fees, and then that sum is divided by monthly income. In the case of the $5,000 income and the $2,500 mortgage payment, a mortgage lender would not provide the loan as the GDS ratio is far too high without even considering the other housing costs.
Total Debt Service Ratio (TDS)
Your total debt service ratio is also considered to ensure that you get a mortgage amount that is easily affordable. The same calculation used for GDS applies for the TDS, but with this debt ratio, all debt obligations are considered whether it’s a car loan, student loan or minimum credit card payments for outstanding balances as well as your housing expenses. TDS ratio can be no higher than 40%-42% on some programs, but this number can vary depending on the program and lender.
How to Ensuring Your Mortgage is Always Affordable?
While it may seem the mortgage amount that you’re approved for based on your debt ratios is much lower than what you believe fits into your budget, this is a realistic amount for a number of reasons.
- As a general rule, having your TDS ratio no more than 40% ensures you have enough cash flow for savings, investments, household repairs, day-to-day living expenses and more.
- When you take a fixed rate mortgage for two or more years, there’s possibility that in that time period your situation or income could change. With a Gross Debt Service ratio of 32% or lesser, it’s more realistic to expect that if that happens, it’s more likely you’ll be able to continue to pay your bills.
- When you buy a home for the first time, you may have fewer expenses but things may change if your life changes. For example, when you make your purchase you may only be a couple and if you have children, later on, your variable expenses may change significantly.
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