Whether you're looking to invest in a rental property or buy a primary residence, getting a mortgage is usually an essential step.
But do you know how your borrowing capacity is determined? More generally, do you know what income and expenses are considered for a mortgage loan?
Let’s take a closer look.
How is borrowing capacity determined?
First, it's important to understand that your mortgage application is submitted to a mortgage broker, bank, or licensed lender. These organizations use certain criteria to determine your borrowing capacity for your investment project.
- Credit score: reflects your ability to manage your day-to-day finances;
- Down payment: demonstrates your seriousness and may make it easier to obtain a loan in the event of a lower credit rating;
- Your current level of debt: may correspond to the repayment of another mortgage, car loan, etc.;
- Your sources of income: your professional stability is a valuable asset here.
What is the mortgage qualification rate?
Once all these elements have been taken into account, the financial institution carries out a simulation that includes the mortgage qualification rate in its calculation.
This predicts a higher interest rate than the one you'll be granted, guaranteeing your ability to repay the loan even if interest rates rise.
What incomes are taken into account when calculating the ability to pay?
Of course, the most important financial resource is your salary from a stable job. However, other types of employment and resources may also be considered:
- Salary: You'll need to provide your pay stubs.
- Business and self-employment income: Provide an average for the last 2 years and proof of income tax.
- Retirement income: Proof that benefits are deposited in a bank account.
- Maternity/paternity leave allowance: Confirmation letter with return-to-work date.
- Alimony: Copy of judgment or other agreement with proof of amount.
- Temporary and permanent disability income: Proof of disability and confirmation letter with a return-to-work date, if temporarily disabled.
- Seasonal unemployment benefit: Employment for at least 2 years, with proof of return to work.
- Variable income or income without guaranteed hours: average of the last 2 years, with proof of taxes.
Is rental income considered?
Rental income can be included in the mortgage calculation. However, the lender takes into account the fact that these resources can vary over time due to unforeseen circumstances: vacancy, unpaid rent, work carried out, etc. Generally, 70% of this income is used to calculate your borrowing capacity.
Calculate your expenses
In addition to your income, it's important to take stock of your expenses in order to obtain a loan:
- Short-term expenses that are likely to disappear: car loan repayments, end of alimony payments, etc;
- Expenses that are likely to occur shortly: planning a trip, the arrival of a child, car repair costs, etc.
The second point is essential because the mortgage lender cannot anticipate the arrival of new expenses in your life. This anticipation work allows you to incorporate these future expenses into your mortgage repayment projections.
Anticipating mortgage-related costs
On the other hand, your advisor's expertise enables him to outline the expenses associated with your future loan, such as:
- Repayment of capital;
- Interest payments;
- Property tax payments;
- Condominium fees.
These factors can make all the difference before you choose a mortgage broker.
Find your debt-to-income ratio (GDS/TDS)
Next, the financial institution that handles your credit file will take into account your income and any known or anticipated expenses that you have shared with them.
These elements will allow them to determine your debt-to-income ratio. This will provide a reliable guide to obtaining a loan that will enable you to continue to meet your current expenses.
There are 2 types of debt-to-income ratios:
- Gross debt service (GDS): must not exceed 32% of your gross annual income for housing costs;
- Total debt service (TDS): provides an indication of the gross annual income you'll need to cover payments on all your expenses.
With this type of calculation, the mortgage lender ensures that you have enough money left over to cover your current expenses.
How to optimize your borrowing capacity
It's possible, however, that your debt-to-income ratio isn't within the limits required to get the loan you want. The first solution is to reduce the budget for your investment project.
The second option is to optimize some of your consumption habits to acquire the home of your dreams. This could mean, for example, buying fewer clothes or eating out less often to bring your finances back into balance.
How much income do you need to buy a home?
Many people ask if you need a certain income to buy a home. To answer this question, it's important to know that there's no specific amount of money you need to come up with, as there are many other factors that can affect your ability to achieve this goal:
- Are you planning to buy alone or as a couple? Borrowing with your spouse will allow you to aim for a higher loan amount and therefore maximize your chances of buying a home.
- What city do you live in? A certain salary won't buy you the same house if you live in Montreal or the suburbs.
You'll know more once your contact has told you how much of a mortgage you're eligible for. This step can be prepared in advance by a professional. A mortgage broker can help you with your loan application and answer any questions you may have.
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