Debt Service
Ratios
In order to provide some protection against default,
lenders will generally restrict the loan to an amount such that ,
given prevailing interest rates, no more than a specified portion
of the mortgagor's qualifying gross income will be allocated to the
repayment of the mortgage debt. In practice, two ratios involving
the borrowers' income have come into common usage in mortgage lending
- the gross debt service ratio (GDS), which includes only housing
debt, and the total debt service ratio (TDS), which includes any and
all debt an applicant may have.
Gross Debt Service Ratio
The gross debt service ratio is the annual first mortgage
payments of principal and interest plus the real property taxes (PIT)
and any condo fees, divided by the qualifying annual gross income.
Generally, lender's use a gross debt service ratio of 27% to 32%.
This limit is based on practice and corporate policy, not law (however
for insured loans, the insurer will generally set the maximum ratio).
GDS = .............................PIT
+ 50% of Condo Fees
......................................Qualifying
Annual Gross Income
Total Debt Service Ratio
The total debt service ratio is defined as the ratio of
annual payments on all debts (first mortgage, property taxes, other
financing, consumer loans, etc.) divided by the qualifying annual
gross income. The total debt service ratio is an attempt to capture
the effect of all annual gross income. The total debt service ratio
is an attempt to capture the effect of all debt obligations on the
prospective mortgagor's ability to service a mortgage loan. Generally,
maximum total debt service ratios of approximately 35% to 40% are
used.
................PIT
+ 50% of Condo Fees + Other Monthly Obligations
.TDS..=________________+
Other Mortgages_______________
----------------------Qualifying Annual
Gross Income
Certain lenders, including CMHC and GE, require a factor for annual
heating costs be included in the debt service ratios.
Loan To Value Ratio
Lenders need to ensure that if they are compelled
to exercise their claims against the property as a result of a borrower
defaulting on one or more covenants of the mortgage, the value of
the security will exceed the amount outstanding on the loan, plus
accrued interest and costs of the action. In order to provide such
protection, lenders will limit the loan to an amount less than 100%
of the lending value for the property, thereby assuming that the monthly
repayments of principal will reduce the outstanding balance at a rate
greater than the potential decline in property values, given reasonable
expectations about future market conditions. The maximum loan amount
is determined by taking a maximum percentage (referred to as the loan-to-value
ratio) of the lending value. This maximum is determined by several
factors, including statutory maximums of institutional lenders, the
lender's general policy, current availability of mortgage funds, risk
on the loan, and the availability of mortgage insurance.
LTV =.........................Principal
Loan Amount
LTV =...............................Property
Value
In general, the legal maximum first mortgage loan-to-value ratio is
75% except for insured mortgages that may be up to 95% loan to value.
Lenders could greatly reduce capital risks by setting very low loan-to-value
ratio is not set too low for several reasons. First, as lenders are
in competition with each other to place mortgage funds, a loan-to-value
ratio that is low relative to that offered by competitive lenders
will lead to very little lending activity. Additionally, setting a
low loan-to-value ratio may result in the borrower seeking additional,
secondary financing, generally at higher interest rates and with shorter
amortization periods, thereby increasing the risk of default due to
the increased demands on the servicing income.
In this context, the concept of the borrower's equity, the amount
of capital invested exclusive of all mortgages and debt charges against
the property, must be considered. The borrower's equity is the "
cushion " against the outstanding debt at any point in time and
the value of the security. High-equity mortgagors (borrowers with
a great deal of their own money invested in the property) will be
concerned with meeting the terms of the mortgage agreement so as not
to endanger their equity. To this end, many lenders require that borrowers
supply a certain minimum amount of equity. Most lenders will require
that a minimum of 5% of the lending value be cash equity from the
borrower's own resources, not by way of any subsequent claims on the
property. |
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