Overview and Tips on Getting Pre-approved for a Mortgage
My goal is to help you realize your dream of owning a home! This is a decision that requires a lot of research and insight, and I am here to provide you with the right tools to succeed.
This is Part 7 of a 11 part series that I will share with you weekly. If you want to read the previous step, please click here.
7. Map out your finances
Let’s say that you don’t have friends or family you can go to for financial support, what should you do next? The next few steps are some additional options you can consider to make home ownership more achievable. The first place to start is to think about your savings and down payment to buy a home. As mentioned earlier, if you have some savings and a steady job, your first move should be to talk to a mortgage broker and get pre-approved. Make sure you talk to an actual person who will collect your financial documents/information and run the numbers for you. If you settle for an online mortgage calculator, you'll probably end up with a generic estimate that could be way off from what you can actually afford. Once you’ve been pre-approved, you’ll know what you can and can’t afford, and if you’re still saving up for a down payment, you’ll know what you need to do to get into a position where you can afford something.
Going through the pre-approval process should give you a bit of a road map for how to get to your first home purchase. Let’s discuss some of the highlights of what this will look like and some of the take-away information you can glean from this exercise. Now everyone’s a bit different in terms of their needs and wants, but for argument’s sake in this example, let’s assume you’re looking for a 2-bedroom condo as your first purchase. This is a common purchase for couples who might be looking to start a family. It’s also a good investment compared to a 1-bedroom condo as it provides a better future rental cash flow opportunity and will be in higher demand for young families looking to purchase if you decide to sell in the future. Currently in 2021, 2-bedroom condos in Victoria are listing between $370,000 and $400,000. To be conservative, let’s take the higher of the two prices. Assuming a 5% down payment at $400,000, you would need to save up $20,000. Now, if you’re a new home buyer seeing this number, I would likely anticipate one of two possible reactions. Either, you're blown away by how cheap it can be to buy your first home, or you’re wondering how on earth you’re ever going to raise $20,000! If you’re in the latter category, have no fear. Lots of people have been in this situation before. Once your mortgage broker has gone through your financials and determined where you’re at, he’s going to want to help you put together a game plan to get to that next step. The core of that game plan is going to revolve around one simple formula: TDS/GDS. What does this stand for? TDS, or Total Debt Service ratio, is a ratio representing your total annual housing and debt servicing cost over your gross annual income. In other words, What are your total housing and debt costs each year versus how much gross income you bring in. This can be represented in the following formula:
Total Debt Service Ratio Formula (TDS):
GDS, or Gross Debt Service ratio, is similar to TDS except this formula only accounts for your total annual housing costs and excludes any other debt obligations. This is represented by the following formula:
Gross Debt Service Ratio Formula (GDS):
Combined you get TDS/GDS, or effectively a ratio between your Total Debt Service (TDS) and your Gross Debt Service ratio (GDS). So, why is this important? Well, this is what tells you how much you can afford with your current income. This can vary depending on who you’re borrowing from for your mortgage. However, since we’re considering a 5% down payment, let’s use the restrictions provided by the Canada Mortgage and Housing Corporation (CMHC) a Federal Crown corporation that exists to provide Canadians with affordable mortgage options. Today their TDS/GDS restriction is 42%/35%. In other words, in order to be eligible to receive mortgage insurance from the CMHC, your combined annual housing and debt service costs must not exceed 42% and your total housing costs must not exceed 35%. So here is where the rubber meets the road. If your TDS can’t exceed 42%, that means your combined housing expenses and debt obligations cannot exceed 42% of your gross annual income. Similarly, if your GDS can’t exceed 35% then that means your total housing expenses can’t exceed 35% of your gross annual income. So, in short, how much you can afford comes down to how much you make versus the combination of how much you expect to pay to own and how much you currently pay for existing debt obligations. Using our example of $400k with 5% here is an example of what we might expect for expenses starting with our GDS ratio:
(Principal) + (Interest) + (Taxes) + (Heat)
So, considering our GDS cannot exceed 35%, this means that in order to afford a home that costs $400,000, your combined gross annual household income must be about $64,500 or greater.
Now in addition to this, we also have to consider any other debt obligations (i.e. student loans, credit card debt, car payments, etc.). This is where TDS comes in. Let’s say you also need to make $1000 a month in student loan payments, in that case your TDS could look something like this:
(Principal) + (Interest) + (Taxes) + (Heat) + (Loan)
In this case, the same gross annual household income of $64,500 would put our TDS at about 54% well above our 42% cut off. Now with this information in hand we have some options to consider in terms of next steps. First off, even though our GDS is fine, our TDS is too high to be able to afford the property we're looking at. This leaves us with a few options to consider:
1. Increase your income,
2. Pay down debt,
3. Consider a cheaper starter home.
Although each of these options may seem like a given, by mapping out our specific financial circumstances and goals we are able to identify a unique strategy to determine how much we need to save and which combination of these steps is best for your specific needs.
*Note, in this case we are assuming an additional 4% mortgage insurance premium added to the cost of the mortgage ($380,000 + $15,200), with the remaining $20,000 covered by the initial 5% down payment. Other costs are excluded for simplicity.
Stay tuned for part 8!
I am a Victoria based local realtor with eXp Kiteke. My commitment to honesty, integrity, loyalty and hard work have been important pillars for me because they drive a high standard of excellent service for my clients. Helping you realize your dream is my goal!
I service Vancouver Island, but my focus is on: Victoria, Sooke, Saanich, Malahat, Shawnigan Lake, Cobble Hill, Duncan, and the rest of the Cowichan Valley.
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