When applying for a mortgage you are going to hear a lot about this topic. I mean this! You are going to hear more than you ever thought you wanted or needed to know about it! The advice is going to come from everyone. This includes family, friends, neighbors, real estate agents and maybe you local butcher too! They all mean well, but the myriads of unconnected information may even leave the bold at heart quite weary. So, here is a road map to guide you through the terrain.
Credit History: When you apply for a mortgage one of the items the mortgage broker is going to do is review your credit report. At the onset of working with you, you mortgage broker is going to ask for consent to acquire and review your credit report. This report is a listing of past and present credit activity. It includes transactions from all public records and trade information that report to that credit agency. This public information includes payment history, amounts owed, length of history, new credit and types of credit used. It also includes any history of bankruptcy, slow payments, collections, judgments and foreclosures. When it is reviewed with you, your mortgage broker will ask questions about it to ensure that the report is accurate, and that it does not contain any errors. Also, the mortgage broker will ask questions for the purpose of explaining areas of the credit report to the underwriter that may need some clarification. Basically, it is a story, your story, of your repayment history.
Ability to Repay the Loan: The capacity and the ability to repay the loan is an essential consideration. Though complex it boils down cash flows in your life. Cash flows are like water through a pipe, how much money is coming in at one end of the pipe and how much money is going out at the other end. So, it is easy to understand that you need an income that is consistent, verifiable and stable. Once the income is verified a couple of tests are applied to it. The first test, Gross Debt Servicing Ratio (GDS). With respect to the home that is to be purchased, in general terms, a borrower can only spend 32% if their gross income on the following: 1) mortgage principal and interest payment, 2) property taxes, 3) heating payments; and if it is a condo 4) 1/2 of the condo fees. The second test, Total Debt Servicing Ratio (TDS). With respect to the home that is being purchased, in general terms, a borrower can only spend 40% of their gross income on everything included in the GDS calculation (principal, interest, property taxes, heating payments (& 1/2 condo fees) plus all other debt. This other debt includes: bank and other loans, car payments, personal loans, credit card payments, court ordered alimony and child support.
Loan to Value: This is the ratio of the loan to the fair market value of the property you wish to purchase.
A qualified and licensed mortgage broker will walk you through this jungle. With my clients this is the first discussion that I have. Even though the industry sets standards and limitations for these ratios, I always want to make sure that my clients are comfortable with the payments they have, and ultimately, it is important to determine if they have room given their cash flows to live comfortably. A home should not be a financial burden. It should be your refuge from the world.