Once the lender has determined the applicants qualifying gross income and expenses they will calculate whether the applicant can afford the mortgage loan based on their ability to carry the shelter costs. Lenders use a ratios approach to determine this ability by setting maximum expenditure amounts.

Shelter costs include:

• The Mortgage Payment
• Property Taxes
• Condominium Maintenance Fees
• Heating Costs

While these are not the entire costs of home ownership, they are the most quantifiable ongoing expenses that will have to be paid.

Gross Debt Service Ratios (GDSR):
The GDSR is the ratio between gross income and shelter costs. The lender will set an upper limit on this ratio. As a general rule mortgage lenders will not allow you to spend more than 30% to 32% of your gross income on shelter costs. If the sum of the mortgage payment, property taxes, condo fees and heating costs exceeds the lenders stipulated Gross Debt Service Ratio, the mortgage will likely be declined, or a revised loan amount offered.

Assume the applicants monthly gross income is $5,000 and they are applying for a mortgage of $200,000 at an annual rate of 8% to be repaid over 25 years. The monthly mortgage payments would be $1,526. The lenders maximum GDSR is 32%.

The lender will add up the shelter costs related to the purchase of the subject property. In this case it is a single family dwelling with property taxes of $100 per month and $50 per month heating costs.

The Shelter Payments amount to 33.5% of the applicants gross income, higher than the maximum allowed by the lender. As such the lender will reduce the financing available to the applicant in line with the 32% GDSR maximum.

With Gross Income of $5,000 per month and a maximum GDSR of 32% the lender will only permit the applicant to have a maximum shelter payment of $1,600 (32% of $5,000)

By subtracting the property taxes of $100 and the Heating Costs of $50 we are left with the maximum gross income available for mortgage repayment. In this case $1,450. This is the applicants maximum mortgage payment.

The $200,000 mortgage the applicant has requested results in a mortgage payment of $1,526 at current interest rates of 8 %, exceeding the applicants maximum mortgage payment and pushing their GDSR above the limit.

The lender will calculate the maximum loan amount using the applicants maximum mortgage payment of $1,450. This results in a maximum mortgage of $189,986, given the current interest rate.

The applicant will have to provide a larger down payment in order to proceed with the purchase of the subject property. Given that their maximum mortgage is $10,014 less than they had anticipated they will have to provide these funds from savings or they will be forced to look for a more affordable home.

Total Debt Service Ratios (TDSR):
The TDSR is the ratio between the sum of both shelter and non shelter financial obligations combined, and gross income. The lender is concerned with the applicants ability to carry costs other than simply the shelter payments. The maximum the applicant will be allowed to spend on both shelter and non shelter financial obligations combined is usually set at 40% to 42%. Total Debt Service Ratios above 42% result in payments that are likely to be unmanageable for the borrower in the long term.

Disregarding the applicants other financial obligations could mean approval of a loan to a borrower that has substantial non shelter financial obligations and may increase the risk of mortgage payment default.

Non Shelter Financial Obligations include:

• Car Payments
• Credit & Charge Card Payments
• Personal Loans
• Lines of Credit
• Finance Company Loans
• Long Term Leases (more than 1 year)
• Tax loans
• Long term RRSP catch up loans (more than 1 year)

Let’s assume that the applicant agrees to a reduction of the mortgage amount to $189,986 in order to bring their GDSR within the allowable 32% limits. The next step is to determine if the borrowers other financial obligations are within the allowable Total Debt Service Ratio limits. Again the shelter costs are summed and any additional costs are also added. If these combined costs do not exceed the 42% maximum the borrower will be past the first step.

If the applicants GDSR is at the 32% maximum they will must not have more than 8% of their gross income committed to non shelter financial obligations, 42% in total.

How Personal Debts Can Affect Housing Affordability:
If the applicants existing non shelter financial obligations are, say 18% of their gross income, the income available for shelter financing is squeezed and reduced to 24% of their gross income. 24% of the applicants $5,000 gross income results in a maximum shelter payment of $1,200. If we subtract the heating cost of $50 and the property tax costs of $100, the resulting maximum mortgage payment is now $1,050.

$1,050 will finance a mortgage in the amount of $137,576 at 8% per annum. This is substantially lower than the $189,986 the applicant would qualify for based solely on the GDSR. The applicants non shelter financial obligations are having a negative impact on housing affordability by reducing their available financing and consequently the applicants purchasing power.

In the graph below the applicant has credit card payments of 7% of gross income and car payments of 6% of gross income. The combined non shelter financial obligations of the applicant equals 18%.

After Taxes Ratios:
The debt service ratio above may appear to leave a good deal of income for all other expenitures. However these ratios are based on gross income and not after tax income. A look at the applicants remaining income after taxes reveals a different picture.

The graph below displays a the maximum GDSR of 32%. After taxes these shelter costs constitute 49% of their disposable income.

The remaining 35% of after tax income does not leave the borrower with much room. In the case of our applicant with a gross income of $5,000 the remaining after tax income they will have is only $1,150 per month. These remaining funds must pay for all other expenses such as food, clothing, medical and dental, vehicle maintenance and operating costs, entertainment, personal property, and savings.

Gross Debt Service Ratios and Total Debt Service Ratios are the maximums set by mortgage lenders.

Purchasers may consider opting for longer mortgage terms in order to avoid the risk of rate increases. In addition, many purchasers are wisely advised to pay down their mortgage, particularly if a renewal at lower interest rates has resulted in a lower mortgage payment.

Set Your Own Debt Service Maximums:
While these maximums set risk guidelines for mortgage lenders, the applicant should also calculate their own maximum GDSR and TDSR. In many cases the lenders maximums are too high for an applicant who wishes to have a little more spending money in their pocket each month. Applicants know their lifestyle priorities and spending habits far better than the mortgage lender. The maximum shelter costs a borrower can handle should be carefully determined by the family regardless of what the lenders maximums are.

Go to Step 3 — Creditworthiness