Know Your Worth

By Sherri Platt

So you know where you want to buy and what kind of house you want, but you want to know if you can get the mortgage required to actually buy it.

A pre-approved mortgage is a must when buying your new condominium or house, but you don?t have to wait on your potential lender just to get a rough idea of what you will be approved for. By using the same formulas and ratios that banks and trust companies use, it's possible to determine on your own the approximate size of the mortgage you will qualify for.

"These can help drastically by letting you know what price range you are in," says Paul Simon, a mortgage broker at Toronto Capital Inc., "It will give you a pretty close figure."

Banks use debt ratios as a basic tool to determine the mortgage you can carry. The first formula used determines your gross debt service ratio. It estimates your potential housing costs including the mortgage principal, interest payments, property taxes, and heating costs. This total should not exceed 32 per cent of your gross monthly income. If you are self-employed, the total should not exceed more than 32 per cent of your net income.

The next ratio that lenders look at is your total debt service ratio. As the name implies, this ratio looks at your whole personal debt picture. It combines your mortgage payments with your other monthly expenses such as credit card debt, loans, lines of credit, or car leases. These total debts should not exceed 40 per cent of your gross monthly income.

In making calculations, Simon says banks will assume you are paying back three per cent of your credit card total and two per cent of your credit line each month. Banks want to see you can pay more than the minimum and still carry your mortgage.

"Before applying for a mortgage, pay off as much of your personal debt as possible," says Simon. "It would be prudent."

Planning ahead can make you a more attractive candidate and increase the amount you are eligible to borrow. He suggests that if you are thinking of buying a home in the future, keep your credit rating as high as possible because a good rating can "drop quicker than it can grow".

First-time buyers should pay special attention to debt service ratios to give them a clear idea of what they can afford. Just because you have been able to pay a certain amount in rent, does not mean you will qualify for a mortgage with the equivalent monthly mortgage payment. Landlords don't go by the same standards as mortgage lenders.

"There is not a standard rule," says Simon about exactly how much you will be approved to borrow. He adds, however, that you can come close with a basic calculation. "For every one dollar you earn you can generally borrow four times that amount. For example, if you earned $10,000 you could borrow $40,000."

Those figures serve only as general standards at banks and trust companies. There may be other options available to you if you consider private sources.

Simon says that people who don't fit the general guidelines may still be eligible for mortgages from private lenders. They may, however be faced with an interest rate that is slightly higher.

As well, a high credit rating and factors such as potential rental income from the property can also tip the scales in your favour. Having an existing mortgage or putting down a larger down payment will also help. While Simon says the only way to really determine your mortgage is to get pre-approved, working with the debt ratio formulas will put you on the right track.