We get questions frequently with people trying to do debt servicing calculations for themselves using their bank’s online mortgage approval tools. While helpful, these tools are set up to be wildly conservative, and to use, in many cases, rates and guidelines that are out of date, or not a true reflection of what is available in the marketplace.
I did this video blog as an explanation about what your banker (or broker) is talking about when they say the words “Debt servicing.”
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TRANSCRIPTION OF THE VIDEO:
Hi everybody, it’s Rowan Smith from the Mortgage Centre. I want to talk today about “debt servicing.” This is something that you are going to hear brokers and bankers bandy about the word as though you know what it means. If you are not in the industry, you probably don’t.
What it essentially means is your ability to make payments on a particular amount of debt based on your provable and documentable income. So where debt servicing becomes important is if you are applying for a mortgage, and let’s say you’ve been paying $850 a month in rent, and you’ve been paying it for 10 years. You want to apply for a mortgage. The bank may or may not believe you qualify for a $850 mortgage payment. Just making an $850 rent does not prove that you have the financial wherewithal, on paper at least, to make that payment from a qualification standpoint. The bank may say that the mortgage, and the deal itself “debt service.”
So where do those numbers come from? What were they looking for?
Debt servicing is a calculation based on your gross taxable income. Now, every bank treats this differently. Every institution has their own quirks, own twists, own rules. If something is less than 20% down, you have to meet insurer guidelines: CMHC, Genworth, AIG. If something is more than 20% down, you still may have to meet those guidelines depending on which bank you go with. Although alternatively, those banks may have their own non-high-ratio or conventional mortgage guidelines that they follow.
So, what are the rules? How is it calculated?
It’s a complicated formulate, so what I’m going to do a verbal of this whole blog post, but I’m also going to post the calculation so you can understand how I’m explaining it. There are two different numbers to be aware of: GDS (Gross Debt Service) and TDS (Total Debt Service).
Gross Debt Service is what percentage of your gross income is being used for housing expenses. So that is going to include the principle and interest on your mortgage, property taxes, some of the strata fees, and in some cases, depending on the lender, heat. So it’s principle, interest, taxes, heat, and strata fees (if applicable). That is what will go into your gross debt service. What they are looking at is you add up all that stuff (and you only use 50% of strata fees – which is a rule that is often overlooked) and you find out what percentage of your monthly income those are going to make up.
Now, what income figure do you use? You don’t get to use just last year’s with big bonuses or something. It depends. Again, this is where it depends. You’re going to hear me say this a lot. That is why guys like me are in business: because we know which banks, which lenders, look at income correctly (based on your situation).
If you are salaried, it’s very straightforward. They’re just going to look at your base salary. If you are commissioned, and you’ve been there a couple of years, they are probably going to look at your last 2 year’s average of your line 150 income on your notices of assessment or T4. If you are self employed, they may use the same thing, or they may “gross up” your income because there are write-offs and what not. Certain lenders use “addbacks” where they will put back non-cash expenses into that notice of assessment figure. Things such as depreciation, vehicle expenses if you are a sole proprietor, and that kind of stuff.
So, knowing what income figure to use is very difficult. Generally a two year average will work (or be accepted) or your base salary. Those are the safest numbers to use.
So what percentage with that Gross Debt Servicing (GDS) are they going to allow? The typical rule, historically, used to be 32% but the industry has kind of changed and generally if you have got an ok to decent credit score it’s going to be 35% of your gross income. On the flip side, if you got exceptional credit, you might be able to go as high as 44% of your gross overall income.
The second ratio is Total Debt Servicing (TDS). That is the second ratio they are looking at. So the bank wants to know two things:
1. Gross Debt Service – What percentage of your income is being consumed by housing expenses
2. Total Debt Service – What percentage of your income is being consumed by housing expenses, and all other monthly obligations that are on your credit bureau
TDS includes things such as: credit cards, lines of credit. Things they don’t look at: cable bills, basic utilities and stuff. They assume that comes in the other 58 or 60 percent of your income.
So, Total Debt Service is everything that was in Gross Debt Service: principle, interest, taxes, heat, and 50% strata fees (if applicable), PLUS all debt payments: car loans, car leases, credit cards, alimony payments, or anything like that.
Now, where is that number? Gross debt service, they didn’t want to see it higher than 35% unless you had exceptional credit and it would be allowed of up to 44%. With Total Debt Service, all your debts, they don’t want to see that any higher than 42% to 44% again depending on credit, and again dependent on bank to bank to bank. There are very big differences across the board.
I’m going to do some examples down below that you can look at and follow through a couple scenarios that I can show you how to calculate it. The rules of thumb are:
1. No higher than 35% GDS
2. No higher than 42% TDS
If you can fit it within those guidelines, you are probably going to get approved based on your taxable income. If you are not declaring something, then don’t think to bring it into the equation, because the bank can’t (use it).
So with that, take a look at the list of information that I’ve put below. If you have any questions or comments, please send it to me or rate the videos.
For the Mortgage Centre, I’m Rowan Smith.
Thanks for watching!
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EXAMPLE 1 OF 3 ON HOW TO CALCULATE DEBT SERVICING
Facts:
Person is salaried and earns $65,000 per year as a base salary ($5,417 per month)
No bonuses or overtime are earned
Mortgage payment they are looking at is $1,400 per month
Property taxes are $100 per month
Heat is $50 per month
Strata fees are $200 per month
Client has a credit card with a $75 per month payment
Client has a car payment of $250 per month
HOW TO CALCULATE GDS:
1400 Mortgage Payment
+100 Property Taxes
+50 Heat
+100 50% of strata fees
$1650 total
1650 / 5417 = 30.29% GDS (within guidelines)
HOW TO CALCULATE TDS:
1400 Mortgage Payment
+100 Property Taxes
+50 Heat
+100 50% of strata fees
+75 Credit card payment
+250 car payment per month
$1975 total
1975 / 5417 = 36.46% TDS (well within guidelines)
CONCLUSION: Assuming no derrogatory credit history, this mortgage will likely be approved at the majority of financial institutions.
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EXAMPLE 2 OF 3 ON HOW TO CALCULATE DEBT SERVICING
Facts:
Person is an hourly employee with a base salary of $30,000 plus bonuses
Total income on line 150 in 2008 was $75,000
Total income on line 150 in 2009 was $81,000
Mortgage payment they are looking at is $1,750 per month
Property taxes are $100 per month
Heat is $75 per month
Strata fees are $300 per month
Client has a credit card with a $200 per month payment
Client has a car payment of $550 per month
HOW TO CALCULATE GDS:
Income they will use is a 2 year average of income (at most banks) so that’s what we’ll use. 2 year average is $78,000 or $6,500 per month.
1750 Mortgage Payment
+100 Property Taxes
+75 Heat
+150 50% of strata fees
$2075 total
2075 / 6500 = 31.90% GDS (within guidelines)
HOW TO CALCULATE TDS:
1750 Mortgage Payment
+100 Property Taxes
+75 Heat
+150 50% of strata fees
+200 Credit card payment
+550 car payment per month
$2825 total
2825 / 6500 = 43.46% TDS
CONCLUSION: This is outside the range that many lenders will allow. However, it is within the guidelines of CMHC and many lenders if the person has exceptional credit. The chances of this getting approved are good, but not perhaps at the lender the client thinks.
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EXAMPLE 3 OF 3 ON HOW TO CALCULATE DEBT SERVICING
Facts:
The applicant is a realtor who is fully commissioned
The realtor’s gross earnings, before write offs in 2008 were $250,000
The realtor’s gross earnings, before write offs in 2009 were $178,000
Total income on line 150 in 2008 was $52,000 (after write offs)
Total income on line 150 in 2009 was $35,000 (after write offs)
Mortgage payment they are looking at is $1,500 per month
Property taxes are $100 per month
Heat is $75 per month
No strata fees
Client has a spousal support payment of $500 per month
Client has a car lease of $550 per month
Client currently lives in a high end condo in Yaletown Vancouver that he rents for $3,500 per month and has never missed a payment in 5 years
HOW TO CALCULATE GDS:
Income they will use is a 2 year average of income of line 150 (at most banks) and they’ll “gross it up” by 15%. So, $43,500 is the two year average of line 150 plus 15% is a total income the banks will use of $50,025 per year or $4,168.75 per month
1500 Mortgage Payment
+100 Property Taxes
+75 Heat
$1,650 total
1650 / 4168.75 = 39.58% GDS which is outside of most bank guidelines unless the realtor has exceptional credit. Let’s assume they do and continue…
HOW TO CALCULATE TDS:
1500 Mortgage Payment
+100 Property Taxes
+75 Heat
+500 spousal support payment
+550 car lease per month
$2700 total
2700 / 4168.75 = 64.76% TDS
CONCLUSION: This is WELL outside the range that banks will allow. This deal is not getting done normally.
I have included this last example to show that even though someone brings in a lot of money, it is TAXABLE income that matters. I have had many bankers say to me, “you win in the tax office, or you win in the bank, but you never win at both!” This is a classic example, that you need to pay taxes on your dollars if you want the banks to consider it.
Now, for those in the industry that are watching and reading this (most of my viewers are in this category), yes, there is maybe the possibility of using some “addbacks” of non-cash expenses to get income higher, or possibly using a “stated income” program, but this is beyond the scope of this blog post and will be heavily dependent on down payment source, credit score, and the reasonability of the realtor’s stated true income.
So there you have it: three scenarios and an explanation of debt servicing. This barely scratches the surface of which bank does what, when, and under what circumstances, and for that, you should be using my services. After all, my services are free for residential bank mortgages, and I offer the best service level in the industry.
Thanks for watching!
