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If you have decided that buying a home is the
right decision for you, then you are ready to
take the next step; that is, determining what
you can actually afford.
Let me start with a word of caution. Before you
contemplate a mortgage for the full amount the
lending institution indicates you are eligible,
think it through carefully. For example, mortgage
interest rates have been fairly low for the past
couple of years. However, if you mortgage to the
maximum amount allowed by the lending institution
and interest rates have increased when it is time
to renew your mortgage in five years, your mortgage
payments may be higher as a result. If you are
not on a strict budget, this may not be a problem
but, if you are, you may have to make some sacrifices
to carry those higher mortgage payments. Of course,
in that amount of time, you may have paid down
your principal and are starting to think about
moving up in the Real Estate market.
So, what can you afford? For the most part, lending
institutions look at two simple formulas when
determining what you can afford for a residential
mortgage. These two formulas are called the Gross
Debt Service Ratio (GDS) and the Total Debt Service
Ratio (TDS). Don't let the terms scare you off.
They are quite easy to calculate!
Your GDS is 30% of your household's total gross
monthly income. The 30% figure is what is normally
considered reasonable for principal and interest
payments on residential mortgages. Therefore,
if your family's gross monthly income was $4,000
you would have $1200 available for principal and
interest payments (30% of $4,000).
Take this one step further to calculate your
TDS ratio. TDS also takes principal and interest
payments into account, but it includes your property
taxes and other fixed monthly expenses such as
a vehicle or credit card payment. To calculate
your TDS, take 40% of your gross monthly income.
This amount is what is normally allowed for total
debt servicing. For example, if you still have
a $4,000 a month gross family income you can use
$1600 for principal, interest, property taxes,
and other debt servicing. In other words, if you
had a monthly car payment of $250 and your monthly
property taxes were $150, you would be able to
use $1200 each month for mortgage principal and
interest payments ($1600 - $250 - $150 = $1200).
Keep in mind that these are general calculations
and ratios. Some lenders may be more generous.
Normally the lending institution will take the
lesser of the GDS or TDS.
To put these examples in perspective in today's
marketplace consider the following: a $100,000
mortgage at 7% amortized over 25 years would cost
approximately $700 a month for principal and interest.
Don't forget these calculations do not take into
consideration the amount of money you have saved
for a downpayment. So if you can afford to service
a $100,000 mortgage and you are entitled to only
put 5% down you can actually purchase in the $105,000
price range.
Note that the calculations and examples provided
in this article are general in nature. Next we
will discuss Investigating the Marketplace with
a Qualified REALTOR®. Until then, keep educating
yourself so you will be prepared to make the move
to home ownership!
David
Weir BA, CD is a Broker with Royal LePage ProAlliance
Realty in Trenton. He has been the top-producing
office REALTOR® since 2001 and his sales in
this area have ranked him in the top 1% of Royal
LePage REALTORS® nationwide from 2005 - 2008.
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