Can’t I get a mortgage that will cover 100% of the cost?
I cannot tell you how often I hear these questions when I speak to a prospective client. The short answer is YES. You do need a down payment.
Recently, the Office of the Superintendent of Financial Institutions changed the mortgage rules for both conventional and nonconventional mortgage borrowers; now, borrowers have to qualify using a minimum rate. A nonconventional mortgage is a mortgage in which your down payment is less than 20%, and a conventional mortgage entails paying 20% or more.
You are required to put at least 5% down up front. However, that is only part of the story.
You also have to ensure that the total debt ratio (TDS) does not exceed 42% of your income and that your gross debt service ratio (GDS) is less than 35%. Your mortgage agent will calculate your TDS and GDS ratios to determine whether you have too much debt. Your TDS is the percentage of your income needed to cover all your household debt (mortgage payment, property tax, condo fees, and so on). Your GDS is the percentage of your income required to cover all of your debt (car payments, student loans, lines of credit, and so on).
When mortgage agents calculate these ratios, they are going to use the stress test interest rate, which is considerably higher than the actual mortgage rate. Today, the stress test interest rate is 5.14%.
So let’s do a quick example with some simple numbers ( I know math but I promise I will make it simple):
You see a townhouse for $200,000, and your gross annual salary is $100,000.
Let’s say you have a down payment of $10,000, which is 5% of the purchase cost of the townhouse. You need a mortgage for $195,000.
Your mortgage stress test payment is $1,150 (5.14% interest over a 25-year amortization, figure rounded).
Your gross monthly income is $8333.33.
GDS = Mortgage Payment + Gas + Property Taxes + Condo Fees X 100
(For this example we are going to make up the monthly gas and tax payment)
GDS= $1,150 + $75 + 120 X 100
GDS = 16%
Yippie! You can easily afford your new home! But wait—there’s more! You need to ensure that your TDS is in line. Here’s how you can find out if it is:
Gross Monthly Income X 42% = The total amount of money that can go towards all your debt.
$8333.33 X 42% = $3,499.86
We already know that you are going to pay $1,345 per month on your mortgage, plus gas and taxes.
Therefore, $3,499.86 – $1,345 = $2,154.86
Therefore, your other debts (car payments, credit cards, lines of credit, student loans, and so on) cannot exceed $2,154.86 per month.
Provided you meet the above thresholds, a credit check will need to be done to see how you manage and pay your bills. This check tells lenders how you have managed your credit in the past. You may want to check out my blog on how to improve your credit score.
If all of that is good, your application will be submitted to several lenders to find you the most suitable mortgage for your circumstance.
Buying a house is the biggest purchase of your life, and getting the right mortgage should be equally as important to you.