Hugo Dos Reis – VINE Group
Obtaining a regular mortgage in 2019 can be quite a challenge with the stress test rules, lender policy changes, et cetera. Obtaining a mortgage for a rental property can be even more challenging with all the very conservative lending criteria lenders use to assess affordability.
There are plenty of tools available that will assess mortgage affordability for a primary residence but very few that will advise on qualifying for a rental property.
In this article, we’ll look at what is involved with a mortgage application, what factors are used to determine affordability, and how clients can better understand their personal position for lending purposes.
Meet our test subjects for this exercise, Mary and John, we’ll determine their affordability for their first rental property purchase. Based on the applications we receive regularly, they are a fair representation of the type of profile we typically see for first time investors. Feel free to use your own data for your assessment. You can contact our team for copies of these worksheets.
Mary and John are looking to purchase a $500,000 rental property that they feel could generate a conservative rental income of $2,500/month.
Now that we have the data from both Personal (A & B) and New Subject Property Expenses (C), we can review Mary and John’s qualifying ratios using these formulas:
Lenders use GDS and TDS as their two main formulas when determining mortgage affordability.
GDS: Gross Debt Servicing (or in our example is C/F).
- GDS gives us an idea of the ratios between income/expenses on the debt related to the subject property alone. Ideally, lenders like to see the GDS around 35% but GDS can be as high as 39%.
TDS: Total Debt Servicing (or in our example E/F).
- TDS provides a breakdown of the ratios between income/expenses on ALL debt items, both Personal and New Subject Property Expenses. Most lenders like to keep this ratio around 42%, but it can go as high as 44% in some cases.
Let’s look at our clients’ ratios:
What does this mean for Mary and John?
Normally, a file like this would not be approved as Mary and John have overextended their monthly credit liabilities.
In a nut shell, our clients’ total expenses represent about 45% of their combined gross income. Note that lenders allow gross income to be used, but if we were to use the actual take-home income, then the TDS ratios would be closer to 65%! This means that almost 65% of a client’s income is absorbed by their credit expenses, and this doesn’t factor in all other lifestyle expenses such as food, gas, entertainment, savings, etc. That’s pretty generous if you really think about it.
What options do we have to get the TDS in line for lender approval?
The clients have two options: increase income or decrease expenses.
Clients that are salary based can always approach their employer for a raise, but we’ll need their already combined $150,000 income increased to about $175,000. This is quite a large jump and would require a very persuasive business case to their current employers. Likely not realistic, but who knows, perhaps this is a long time coming for Mary and John!
A more realistic option is to review their expenses and see if they can be reduced. One personal expense that stands out is their $500/month credit expense. This is a result of their estimated $17,000 combined credit card and line of credit balances that they are carrying. If Mary and John were to payout the $17,000 balance from their own sources then we can reduce the monthly expense by $500.
Here is an updated profile assuming the credit expenses are paid out:
A case study like this one outlines the importance of planning and taking a long-term approach to mortgage pre-positioning. Identifying where you currently stand and making any adjustments required to get where you need to go are essential in being a strategic investor and navigating the ever challenging lending environment that we find ourselves in 2019.