Outdated mortgage formulae mean trouble

Shopping for a home? No doubt you’ll head off to the bank where your mortgage lender will ask for some numbers they need to calculate how much you can borrow. They’ll be calculating both your GDSR (gross debt service ratio) and your TDSR (total debt service ratio). And they’ll pronounce the amount you’ll be able to safely borrow and repay. Maybe.

Maybe not.

First, let’s look at what these ratios are how they’re calculated. GDSR is the percentage of your gross income required to pay basic housing costs including your mortgage payments, property taxes, heating and condo or strata fees (if you have any). They add up these numbers and then divide by your monthly gross income.

So if your monthly mortgage payment is $1,350, your average monthly property taxes are $335 and your heating costs are $100 a month, your total would be $1,785. Now let’s say you make $67,000 which works out to $5,583 a month. The next step is to divide your total monthly payment by your gross monthly income and multiply by 100. So, 1785 ÷ 5583 x 100 = 31.97%.

Financial institutions want to see your GDSR under 32%, so you’d be just on the edge of their criteria. If they were trying to build up their mortgage business, you’d get the mortgage. If credit was in tight supply and they were watching their Ps and Qs, you might be declined. However, under their rules they won’t give you a mortgage if your GDSR is over 32% because if you’re spending more than 32% on “basic” housing costs that could make it difficult to cover your other expenses.

TDSR is the percentage of your gross income required to cover basic housing costs plus all your other debts, including your car loan, consolidation loans, lines of credit, student loans and credit card limits.

Keep in mind if you have 10 credit cards each with $2,000 limits, lenders will count that as $20,000 you have already borrowed, regardless of whether you’re carrying a balance or not since you can draw on those credit card limits at any time. Ditto your line of credit; regardless of how much you’ve used, the lender will count your limit against you for the purpose of the TDSR calculation. Lenders want your TDSR to be under 40%.

Here’s where the theory and reality of debt service ratio come to blows.

If you’re making $67,000 a year, you’re not taking home $5,583 a month. Nope, you’ve got to give the tax man his pound of flesh first. If you live in Alberta you’ll pay $14,775 in tax on that gross income. If you’re in Nova Scotia, you’ll pay $17,854. If you’re in Ontario you’ll pay $14,324 and if you’re in B.C. you’ll pay $13,681.

Let’s use Alberta as our example. So you make $67K and you pay $14,775 in income tax, which leaves you with $52,225, or $4,352 per month, in income.

Your basic housing costs of $1,785 divided by your net monthly income of $4,352 means you’re spending 41% of your net income on your home. And that’s before we take into account home insurance, maintenance and electricity, water and sewage and any other costs you may have to pay.

Assuming you spend $100 a month on insurance and set aside $300 for maintenance and everything else, your percentage jumps to 50%! And that’s how so many people have ended up spending half their income on their shelter costs.

My rule of thumb is to spend no more than 35% of your income on shelter. If you have no other debt at all…then there’s another 15% you could roll into shelter (but wouldn’t you rather spend that on life?)

Can you imagine if you have a car payment, if you’re shelling out big bucks for day care, if you suddenly find yourself living on one income? And what if you have a whole bunch of deductions off your pay cheque aside from tax: CPP, EI, union dues, medical benefit premiums and the like. Is it any wonder that people turn to credit cards and lines of credit to make ends meet?

The problem lies in the fact that these ratios are way out of date. Why is gross income even on the table? Even after years and years of saying, “You don’t make your gross income, you and the tax man make your gross income,” no one in the ivory towers has woken up to this reality.

If you want to know why Canadians are carrying too much debt, this is reason No. 1. Don’t even get me started on the willy-nilly handing out of lines of credit and credit cards. My blood pressure just can’t take it.