Tag Archives: debt service

How Self Employed Borrowers get a Mortgage in Vancouver – Rowan Smith Mortgage Broker Explains

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Transcript of Video Blog:

Hi, everybody. Rowan Smith from the Mortgage Center. I want to talk today about self-employed people and what the banks want to see from you in terms of the income documentation.

Like everybody else, they want to see notices of assessment to prove that you’re filing your income-tax, as in you have no arrears, and they want to see how much your filing on there.

But what about somebody who’s been a plumber for 25 years and finally decides to go out on their own. They go out on their own and they’re making way more money, but they’ve only been doing it for a year and a half.

Here’s the thing, that’s a tricky situation for a bank. The bank wants to see that you’ve got a two-year track record of income. But if you were employed back then and now you’re self-employed, how do they make the connection?

Now, not all banks, but several of them have a much more open idea here. What they’ll do is they’ll look at your historical earnings as a plumber, or whatever your job was. As long as you transitioned into self-employment in the same industry doing the same thing they’ll use an average of income over those years, including your start-up years, but also including your years as a salaried employee.

This is particularly important for a guy who’s been self-employed for only one year but has been doing something for 25 years. Often times they move to self-employment not because they were foolish but because they saw there was a lot more money to be made if they were the boss rather than just collecting a salary.

So, if you know somebody in this circumstance, someone who’s been told, “You haven’t been in business long enough,” but they’ve been doing the same job for a very long time, have them contact me. It’s Rowan Smith from the Mortgage Center.

Bi Weekly Payments – How they Help – Explained by Rowan Smith a Vancouver Mortgage Broker

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Transcript of Video Blog:

Hi, everybody, it’s Rowan Smith with the Mortgage Center. I’m here to talk about biweekly payments and why they pay your mortgage down faster.

Now, I want to use a nice simple example to show you why this works, because it’s no magic and it has nothing to do with just making more frequent payments. You are, in fact, paying extra money when you pay a biweekly accelerated and you’re paying it down quickly.

So, here’s how it works. Let’s use a nice round number of 1,000 dollars. If that was your monthly mortgage payment, you would pay 12 times a year, you’d pay 12,000 dollars throughout the year. But if you were paying biweekly accelerated, they chop that payment in half.

So, 500 dollars times, times how many? Well, there’s 26 biweekly payments in the year. So, there’s not 24. People often confuse that, because they assume 12 months, 24 payments. There’s not. There’s 26 biweekly payments throughout the year.

It’s like when, if you’ve ever had a paycheck that comes in every 2 weeks, and then, twice a year, you’ll receive a paycheck, but you won’t have the corresponding obligations. It’s almost like found money. But it’s not. It’s just because the biweekly payments are 26 times throughout the year.

So, 26 times 500 is 13,000. So, like I said, on monthly, with 12,000. On biweekly, you’re at 13,000. So, you’re actually paying 1,000 dollars or one full extra payment per year. That has an effect of shaving several years off your mortgage. Depending on 25 or 30 years, it’s anywhere between 4 and 5 years that it knocks off right off the top.

So, if you want to pay it down a little bit quicker, accelerated, or biweekly accelerated, is the way to go. If you’d like that, and you know somebody else would like to pay down their mortgage faster, have them contact me.

This is Rowan Smith from the Mortgage Center.

A “Variable” Mortgage is NOT and “Open” Mortgage – There is a difference

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Transcript of Video Blog:

Hi, everybody. I want to address a very common myth, and that’s that people think their variable rate mortgage, because it is open to fluctuations, is in fact an open mortgage. That’s not the case. There’s a lot of confusion as to what is an open mortgage versus a variable mortgage versus a closed mortgage or a fixed mortgage.

So, a fixed mortgage, well, obviously, your rate is fixed. You don’t have to worry about fluctuations in prime rate. For whatever the length of your term, whether it’s one or five years, your rate is fixed. Now, all fixed rates that we get here are closed. Meaning, to break that term — if you sell the home or you try to refinance during the term — you’re going to owe.

Typically, the penalty is the interest rate differential, the greater of the interest rate differential or three months of interest. Now, if rates have fallen substantially, you can expect the penalty to be quite large because it will be the interest rate differential.

If you do a search, some of the other blogs that I’ve done on penalties, you’ll see that there’s — I’ve explained the method of interest rate differential penalty calculation at a little more length. But in any case, if you have fixed — closed in almost every single case.

If it’s not a fixed or closed, then you’re going to be looking at a variable rate. Now, there is two types of variables — variable open and variable closed. The only difference between the two, other than rate, is that variable open can be paid off at any time with no pre-payment penalty whatsoever. The variable closed typically has a three-month interest penalty.

So you say, “Well, why would anybody take variable closed when they can take a variable open?” The difference is rate. Variable opens typically right now run you anywhere from prime plus 0.8 to prime plus 1.0. Prime rate is 3%, so that means your rate would be 3.8% to 4%.

Compare that to a variable closed mortgage will be at prime minus 0.75 or prime minus 0.8. So you’re looking at almost a point and a half to two-point spread between the two. So you can be paying 2.25% or you can be paying 3.75%. Clearly, the variable closed is a better deal if you’re going to hold the property for any length of time.

So people often come to me and say, “Well, I intend to sell it maybe in the next year or something.” Well, even in those cases, oftentimes the savings over a year-long period of time of getting the lower variable closed rate is better than paying no penalty, but paying a much higher rate as you go along.

So the important distinction here is that your open mortgage, you want to figure out how long are you going to hold that property? Open and avoiding a penalty may sound nice in principle, but if you actually end up spending thousands of dollars more over the life of the mortgage, why bother avoiding the penalty just to pay more monthly? For the Mortgage Center, I’m Rowan Smith.

Debt Servicing – How to Calculate It (Instructional)

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Transcript of Video Blog:

Hi everybody, it’s Rowan Smith with The Mortgage Center. We’re going to try something a little different this week, and we’re going to cover something that’s very commonly requested of me, which is details on debt servicing, what is it, and how to calculate it.

So there’s two main ratios that the lenders use when they’re calculating debt servicing. The first is GDS for gross debt service, and the second is TDS for total debt service. Gross debt service or GDS, which is the first ratio we look at includes your principal, interest, taxes and heat, and what we’re trying to do is a find a percentage of your gross income that this equals.

So principal and interest is effectively your payment, so whatever your payment is plus taxes and heat. A good rule of thumb is that GDS should not exceed 35%. I mean, yes, there’s exceptions to this, but that’s a good base-line if you’re trying to figure a rough equivalent of what you can afford.

Total debt service on the other hand includes not only principal interest, taxes and heat, but also any other debt payments or obligations. Now not everything is included in there, and we’ll get to that later, but all debt payments. A good rule of thumb is that TDS should not exceed 42%.

Exceptions up to 44% and beyond are available, depending on someone’s credit score and the particular program that we’re using and applying for. Of course the amount of down payment you have also plays into this, so it’s important to know exactly what rule you’re working at before you go in and apply for something.

So let’s go through GDS, we’ll actually look at how to calculate it. This is a scenario, the common scenario that you see. Someone has an e-mortgage payment that’ll work out to $2,500 a month, and that couple makes $120, 000 a year, combined, both of their jobs, so $10,000 a month. Property taxes are $3, 600 per year, that works out to $300 per month, and heat is $100 at most lenders.

There’s a few that’ll use $85, some of that will use less, that’s conned over. It’s not a big difference, $100 should be used for roundness. Strata fees on the townhouse they’re buying are $330 per month. Now currently, banks only use 50% of the strata fees to count towards GDS and TDS, you have to remember that when you’re working through it. If it is a strata property, meaning an apartment, townhouse, condo, something like that, and there are fees, then only 50% of those are used.

So here’s the calculation. You make $2,500 payment, plus $300 taxes, plus $100 heat and $165 strata fees equals $3,065. $3,065 divided by the $10,000 monthly income, as expressed as a percentage, is 30.65% gross debt service, or GDS, which is within my 35% guideline I gave you. So based on GDS, yes this would be approved.

TDS is a little bit different, similar but different. Same scenario, same payments and all that. The only difference is that last line there, since the client has a $300 per month car payment, and those $8,000 in credit card debt. So here’s the calculation, and I want to note here, for credit cards, most banks use 3% of the amount owing to determine what we’re payment will be. So in this case, $8,000, 3%, $240 will count towards TDS per month. You notice I like to convert everything to monthly numbers, because that tends to be how most people run their budgets, so it’s how I do that.

$2,500 mortgage payment, plus $300 taxes, $100 heat, $165 strata fees, plus the $300 car payment and $240 equals $3,605 per month counted towards their $10,000 income. $3,605 divided by $10, 000 equals 36.05% TDS, total debt service. Again, it’s within my range of 42% that I gave you. So the two ratios to keep in mind are GDS and TDS, 35, 42 respectively. There are exceptions, but for now those are important.

A couple of notes on TDS. People often say to me, “Well wait, if I’ve got monthly bills, what about my cable bill and my cell phone bill?” No. Cable bills, cell phone bills, telephone or Internet bill are not included. Other things not included in monthly RSP contributions, but the loans are; car insurance, house insurance, repairs and maintenance to property and income taxes.

Now you may say, “Well wait, a lot of those are really important expenses, things that I have to pay for” but that’s why we only use 42% or 44% of the TDS calculations. The other 56% to 58% are for those other expenses that everybody else pays. Some things that must be included in TDS and that often people wish were not: child support payments, alimony or spousal support payments, any other loan, credit card, line of credit or monthly debt obligation, car lease payments. If you’re making another year on account, then a year of payment may count towards TDS.

Now it’s a lot of numbers. If you have any questions, feel free to give me a call. I’m happy to run through your situation for free. Everybody’s is different, and it takes some experience to know what numbers actually have to be included, what are not included. So again, for The Mortgage Center, I’m Rowan Smith.

First Time Home Buyer Rights and Advantages

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Transcript of Video Blog:

It’s Rowan Smith from the Mortgage Centre. I want to address a very common myth that I hear about, that clients will come to me and say, “Well, I’m a first-time home-buyer, so don’t I get a better rate on my mortgage?”

The answer is absolutely not. Everybody is going to get the same rate based on their credit score and their income and whatnot. Where you get the benefits as a first-time home-buyer is being A, being able to take money out of your RRSP, tax-free, up to $25,000 per person on your first purchase of your home.

And you’re allowed to avoid the Property Transfer Tax, up to a purchase price of 425. Anything over 425 but up to 450, there’s a sliding scale. If you’re buying something over $450,000, it doesn’t matter if you’re a first-time home-buyer or not, you’re going to pay the full Transfer Tax.

The government, I guess, looks at it and says if you can afford a home that that’s expensive, that you shouldn’t be getting the tax break to being with.

So again, just as a recap, RRSPs can be used tax-free for your down payment, and Property Transfer Tax. Those are the only benefits, the only things you get to avoid as part of being a first-time home-buyer. There is no special incentive on rate, I’m sorry. For the Mortgage Centre, I’m Rowan Smith.

Down Payment – What is Needed For the Banks Paperwork

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Transcript of Video Blog:

Hi everybody. It’s Rowan Smith at the Mortgage Centre. What I wanted to address today is one of the more common confused elements with down payment. Down payment is something that’s very important with your mortgage, but proving not only that you have the money but where the money came from is also very important.

Let me provide you an example. When you go to put, say, 20 percent down on a $500,000 place, that’s $100,000. The bank is going to ask you for either 90 days of bank statements showing that money in your account, or if it’s coming from family — that they’re giving it to you — then, they can get a gift letter.

Where people get confused is they always say, “Well, maybe I’m not really going to get the money from my savings. I might be getting $20,000 from a friend and $25,000 from my brother. And oh, I’ll pay them back later, but for now they’re going to give it to me.”

That’s not really the way that it’s allowed to work. Banks want to know that the down payment does not create any outside interests in the property. When you get money from a friend or get money from a relative, if they’re loaning it to you, frankly you should have a payment on that. Even though most times you don’t, the bank will look at it as though you would.

And secondly, does that other person have an interest in your property? So while it may seem very clear that they’re not on the title, and thus, they don’t, one can argue if they’ve given you the down payment, the fact of the matter is banks don’t want to get involved in that discussion. They don’t want to be pulled into something with multiple parties and competing interests in their security, which is the home.

So you can be expected to have to provide 90 days of bank statements showing the down payment being in your name. Now if it’s not in your name, we have to have a very good story of why. It can be money that’s accumulated within those 90 days. Perhaps you’ve had a large deal close in whatever your business is and you get a large check. That’s all very legitimate.

Then, you should be able to provide invoices or contracts or something to substantiate that the money is, in fact, yours and is not being borrowed or gotten from other sources of debt — like family that are slipping you some money in the time being until you sell the property in a few years. If you have any questions with down payment because perhaps you’re getting a hard time at your bank, give me a call. It’s Rowan Smith from the Mortgage Centre.

Debt Servicing – Ratios – What Does it Mean?

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Transcript of Video Blog:

Hi everyone, it’s Rowan Smith with the Mortgage Centre. I want to address one of the more common misunderstood elements of mortgage financing, and that’s debt servicing. And what percentage of your income is allowed to go towards mortgage payments, principal, interest, taxes, heat, or other debt payments. There’s two main ratios that we use in the mortgage industry gross debt service ratio, and the total debt service ratio. The gross debt service ratio looks at your gross income and says what percentage of your gross income is being used by your mortgage payments, your principal and interest, taxes, and heat.

Now, the old rules used to be 32, but now there’s ways that we can get as high as 44 percent of your income gross income before taxes is allowed to be used towards debt servicing. Now you have to qualify for that with a very clean credit rating. If your credit has some problems on it, you might only be allowed to use 35 percent of your gross income.
That’s where someone like me comes in who can look at your situation, and know the appropriate number, the appropriate amount of money that you’re allowed to have to qualify for mortgage payments each month. So that’s the first main ratio, gross debt servicing. And that’s looking at, again, principal, interest, taxes and heat.

You’ll notice I made no other mention of credit cards. Well, that’s where the total debt service ratio, or TDS, comes in. Total debt service looks at what percentage of your income is being used for all debts, mortgage, principal, interest, taxes, heat, and car lease, car loan, alimony support payments, any ongoing obligation that a person has, credit cards, lines of credit, that type of thing.
So the general rule there is no more than 44 percent. And you may say, “But Rowan, you’ve said 44 percent was the maximum that could be used for mortgage.” Well, typically the ratios that we use are 35 percent of your income towards housing so principal, interest, taxes and heat.

And 44 percent on the other side as the upward threshold for all of that, plus your other debts. Now, if you’re at 44 percent debt servicing chances are you’re eating a lot of macaroni, and not able to afford a lot of lifestyle that you would otherwise like.

But nonetheless, it’s important just to look at what income number are they’re using 44 percent of what number? Well, that’s typically 44 percent of your gross before tax earnings from all sources. So if you have two part time jobs, well then yes, you can use a total amount of that particular sum of all income.

So if you have somebody that’s being told that they can’t qualify because they’re using too high of a ratio their debt servicing ratios are out of line perhaps I can take a look at it and see if there’s another lender who has more relaxed guidelines, or maybe their bank is being particularly conservative because of their credit score.

Any of these ratios I’ve discussed in this are entirely dependent on your credit score, and how clean it is. That will enable you to stretch, in the bank’s eyes, to use more money for housing expenses and other debt payments. For the Mortgage Centre, I’m Rowan Smith.

Debt Servicing – What is it and How to Calculate it?

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We get questions frequently with people trying to do debt servicing calculations for themselves using their bank’s online mortgage approval tools. While helpful, these tools are set up to be wildly conservative, and to use, in many cases, rates and guidelines that are out of date, or not a true reflection of what is available in the marketplace.

I did this video blog as an explanation about what your banker (or broker) is talking about when they say the words “Debt servicing.”

Get the Flash Player to see this content.

TRANSCRIPTION OF THE VIDEO:

Hi everybody, it’s Rowan Smith from the Mortgage Centre. I want to talk today about “debt servicing.” This is something that you are going to hear brokers and bankers bandy about the word as though you know what it means. If you are not in the industry, you probably don’t.

What it essentially means is your ability to make payments on a particular amount of debt based on your provable and documentable income. So where debt servicing becomes important is if you are applying for a mortgage, and let’s say you’ve been paying $850 a month in rent, and you’ve been paying it for 10 years. You want to apply for a mortgage. The bank may or may not believe you qualify for a $850 mortgage payment. Just making an $850 rent does not prove that you have the financial wherewithal, on paper at least, to make that payment from a qualification standpoint. The bank may say that the mortgage, and the deal itself “debt service.”

So where do those numbers come from? What were they looking for?

Debt servicing is a calculation based on your gross taxable income. Now, every bank treats this differently. Every institution has their own quirks, own twists, own rules. If something is less than 20% down, you have to meet insurer guidelines: CMHC, Genworth, AIG. If something is more than 20% down, you still may have to meet those guidelines depending on which bank you go with. Although alternatively, those banks may have their own non-high-ratio or conventional mortgage guidelines that they follow.

So, what are the rules? How is it calculated?

It’s a complicated formulate, so what I’m going to do a verbal of this whole blog post, but I’m also going to post the calculation so you can understand how I’m explaining it. There are two different numbers to be aware of: GDS (Gross Debt Service) and TDS (Total Debt Service).

Gross Debt Service is what percentage of your gross income is being used for housing expenses. So that is going to include the principle and interest on your mortgage, property taxes, some of the strata fees, and in some cases, depending on the lender, heat. So it’s principle, interest, taxes, heat, and strata fees (if applicable). That is what will go into your gross debt service. What they are looking at is you add up all that stuff (and you only use 50% of strata fees – which is a rule that is often overlooked) and you find out what percentage of your monthly income those are going to make up.

Now, what income figure do you use? You don’t get to use just last year’s with big bonuses or something. It depends. Again, this is where it depends. You’re going to hear me say this a lot. That is why guys like me are in business: because we know which banks, which lenders, look at income correctly (based on your situation).

If you are salaried, it’s very straightforward. They’re just going to look at your base salary. If you are commissioned, and you’ve been there a couple of years, they are probably going to look at your last 2 year’s average of your line 150 income on your notices of assessment or T4. If you are self employed, they may use the same thing, or they may “gross up” your income because there are write-offs and what not. Certain lenders use “addbacks” where they will put back non-cash expenses into that notice of assessment figure. Things such as depreciation, vehicle expenses if you are a sole proprietor, and that kind of stuff.

So, knowing what income figure to use is very difficult. Generally a two year average will work (or be accepted) or your base salary. Those are the safest numbers to use.

So what percentage with that Gross Debt Servicing (GDS) are they going to allow? The typical rule, historically, used to be 32% but the industry has kind of changed and generally if you have got an ok to decent credit score it’s going to be 35% of your gross income. On the flip side, if you got exceptional credit, you might be able to go as high as 44% of your gross overall income.

The second ratio is Total Debt Servicing (TDS). That is the second ratio they are looking at. So the bank wants to know two things:

1. Gross Debt Service – What percentage of your income is being consumed by housing expenses
2. Total Debt Service – What percentage of your income is being consumed by housing expenses, and all other monthly obligations that are on your credit bureau

TDS includes things such as: credit cards, lines of credit. Things they don’t look at: cable bills, basic utilities and stuff. They assume that comes in the other 58 or 60 percent of your income.

So, Total Debt Service is everything that was in Gross Debt Service: principle, interest, taxes, heat, and 50% strata fees (if applicable), PLUS all debt payments: car loans, car leases, credit cards, alimony payments, or anything like that.

Now, where is that number? Gross debt service, they didn’t want to see it higher than 35% unless you had exceptional credit and it would be allowed of up to 44%. With Total Debt Service, all your debts, they don’t want to see that any higher than 42% to 44% again depending on credit, and again dependent on bank to bank to bank. There are very big differences across the board.

I’m going to do some examples down below that you can look at and follow through a couple scenarios that I can show you how to calculate it. The rules of thumb are:

1. No higher than 35% GDS
2. No higher than 42% TDS

If you can fit it within those guidelines, you are probably going to get approved based on your taxable income. If you are not declaring something, then don’t think to bring it into the equation, because the bank can’t (use it).

So with that, take a look at the list of information that I’ve put below. If you have any questions or comments, please send it to me or rate the videos.

For the Mortgage Centre, I’m Rowan Smith.

Thanks for watching!

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EXAMPLE 1 OF 3 ON HOW TO CALCULATE DEBT SERVICING

Facts:
Person is salaried and earns $65,000 per year as a base salary ($5,417 per month)
No bonuses or overtime are earned
Mortgage payment they are looking at is $1,400 per month
Property taxes are $100 per month
Heat is $50 per month
Strata fees are $200 per month
Client has a credit card with a $75 per month payment
Client has a car payment of $250 per month

HOW TO CALCULATE GDS:
1400 Mortgage Payment
+100 Property Taxes
+50 Heat
+100 50% of strata fees
$1650 total

1650 / 5417 = 30.29% GDS (within guidelines)

HOW TO CALCULATE TDS:
1400 Mortgage Payment
+100 Property Taxes
+50 Heat
+100 50% of strata fees
+75 Credit card payment
+250 car payment per month
$1975 total

1975 / 5417 = 36.46% TDS (well within guidelines)

CONCLUSION: Assuming no derrogatory credit history, this mortgage will likely be approved at the majority of financial institutions.

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EXAMPLE 2 OF 3 ON HOW TO CALCULATE DEBT SERVICING

Facts:
Person is an hourly employee with a base salary of $30,000 plus bonuses
Total income on line 150 in 2008 was $75,000
Total income on line 150 in 2009 was $81,000
Mortgage payment they are looking at is $1,750 per month
Property taxes are $100 per month
Heat is $75 per month
Strata fees are $300 per month
Client has a credit card with a $200 per month payment
Client has a car payment of $550 per month

HOW TO CALCULATE GDS:

Income they will use is a 2 year average of income (at most banks) so that’s what we’ll use. 2 year average is $78,000 or $6,500 per month.
1750 Mortgage Payment
+100 Property Taxes
+75 Heat
+150 50% of strata fees
$2075 total

2075 / 6500 = 31.90% GDS (within guidelines)

HOW TO CALCULATE TDS:
1750 Mortgage Payment
+100 Property Taxes
+75 Heat
+150 50% of strata fees
+200 Credit card payment
+550 car payment per month
$2825 total

2825 / 6500 = 43.46% TDS

CONCLUSION: This is outside the range that many lenders will allow. However, it is within the guidelines of CMHC and many lenders if the person has exceptional credit. The chances of this getting approved are good, but not perhaps at the lender the client thinks.

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EXAMPLE 3 OF 3 ON HOW TO CALCULATE DEBT SERVICING

Facts:
The applicant is a realtor who is fully commissioned
The realtor’s gross earnings, before write offs in 2008 were $250,000
The realtor’s gross earnings, before write offs in 2009 were $178,000
Total income on line 150 in 2008 was $52,000 (after write offs)
Total income on line 150 in 2009 was $35,000 (after write offs)
Mortgage payment they are looking at is $1,500 per month
Property taxes are $100 per month
Heat is $75 per month
No strata fees
Client has a spousal support payment of $500 per month
Client has a car lease of $550 per month
Client currently lives in a high end condo in Yaletown Vancouver that he rents for $3,500 per month and has never missed a payment in 5 years

HOW TO CALCULATE GDS:

Income they will use is a 2 year average of income of line 150 (at most banks) and they’ll “gross it up” by 15%. So, $43,500 is the two year average of line 150 plus 15% is a total income the banks will use of $50,025 per year or $4,168.75 per month
1500 Mortgage Payment
+100 Property Taxes
+75 Heat
$1,650 total

1650 / 4168.75 = 39.58% GDS which is outside of most bank guidelines unless the realtor has exceptional credit. Let’s assume they do and continue…

HOW TO CALCULATE TDS:
1500 Mortgage Payment
+100 Property Taxes
+75 Heat
+500 spousal support payment
+550 car lease per month
$2700 total

2700 / 4168.75 = 64.76% TDS

CONCLUSION: This is WELL outside the range that banks will allow. This deal is not getting done normally.

I have included this last example to show that even though someone brings in a lot of money, it is TAXABLE income that matters. I have had many bankers say to me, “you win in the tax office, or you win in the bank, but you never win at both!” This is a classic example, that you need to pay taxes on your dollars if you want the banks to consider it.

Now, for those in the industry that are watching and reading this (most of my viewers are in this category), yes, there is maybe the possibility of using some “addbacks” of non-cash expenses to get income higher, or possibly using a “stated income” program, but this is beyond the scope of this blog post and will be heavily dependent on down payment source, credit score, and the reasonability of the realtor’s stated true income.

So there you have it: three scenarios and an explanation of debt servicing. This barely scratches the surface of which bank does what, when, and under what circumstances, and for that, you should be using my services. After all, my services are free for residential bank mortgages, and I offer the best service level in the industry.

Thanks for watching!