When buying a home, the generally accepted practice is that the purchaser spends no more than 25% of their gross monthly income on principal, interest and taxes. Financial institutions use established formulas to calculate the exact amount of a mortgage loan they think you can reasonably handle, taking into account your existing debts and the various other expenses that are involved in owning a home.

The two most commonly used financial formulas are:

1. Gross Debt Service (GDS) ratio: the percentage of gross income (before deductions such as income tax) required to cover the costs associated with your home, such as mortgage payments, property taxes and heating; and
2. Total Debt Service (TDS) ratio: the percentage of gross income (before deductions such as income tax) required to cover the costs associated with your home, such as mortgage payments, property taxes and heating, plus other debts, such as credit card payments, car payments or lines of credit.

GDS and TDS requirements

For all buyers:

• the maximum spending limit used by most lenders is 39% of income on home-carrying costs (GDP) like mortgage payments, heat and taxes; and
• the maximum TDS spending limit used by most lenders is 44%.

Mortgage lenders will use these ratios to determine the maximum amount they will lend you.

Minimum Qualifying Rate/Stress Test

Canadian home buyers are required to take a mortgage “stress test” to qualify for a mortgage at a bank. Under this test, home buyers qualify for their mortgage using a minimum qualifying rate (MQR). The requirement was created to ensure that the home buyer could still afford the mortgage if interest rates were to rise.

The minimum qualifying rate is:

• the greater of the rate negotiated with the mortgage lender plus 2%, or 5.25% – whichever is higher.

This requirement also applies if you already have a mortgage (insured or uninsured) and:

• you refinance your home,
• you take out a home equity line of credit, or
• you have an uninsured mortgage and change lender

This requirement does not apply:

• to grandfathered loans (loans made before October 17, 2016, and their renewals),
• to mortgage renewals, as long as they are with the borrower’s existing lender,
• if you refinance your home,
• if you take out a home equity line of credit, or
• if you have an uninsured mortgage and change lenders.

Federally regulated Canadian banks must establish loan to value (LTV) limits that are in line with the stress test and take risk into consideration. These LTVs are to be updated by the banks to reflect changes in the housing market and the economic environment.

Loans through other lenders:

Further, banks are prohibited from arranging loans through other lenders for residential mortgages, where the loan is not within the LTV limit. The restriction only applies to new transactions and does not apply in cases where the other lender providing the secured funding is municipal, territorial or provincial, or the federal government.

For more information, visit CMHC, Canada Mortgage and Housing Corporation, a government owned institution that is the main provider of housing and mortgage insurance information in Canada.

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