How to keep your debts in check
A formula for determining if you qualify for a loan or mortgage
CHRIS IBBOTSON STORYBLOCKS
PREMIER CROSSWORD PUZZLE
Dear Money Lady, A couple of years ago, you had an article on how to qualify with a bank. Could you enlighten me on what to do? Jim Dear Jim, That’s a great idea, especially at the beginning of the year when people are always thinking about money and future purchases. So, let’s all think like a banker. Stress about money comes when we take on too much debt, accumulate too fast, or make purchases without thinking it through. Here is an easy trick that lenders use to establish the servicing for any increases to your lifestyle. It is a great way for you to determine instantly whether a larger mortgage payment, extra car loan or additional loan payment can fit into your budget. I want you to determine your TDS, Total Debt Service ratio. Think of your TDS ratio like a BMI score for a healthy lifestyle and do not go over 40 per cent, no matter how much you want to. Do not make the mistake of being lured in by instant gratification – sticking to this maximum ensures you will always be able to meet your financial commitments. Here’s how it works: first, determine your monthly mortgage payment or rent, property taxes, and debt or loan payments. You will also need to take your annual gross income and determine the monthly amount. This is your gross income, not take-home income. So, if you earn $50,000 per year, your monthly gross income is $4,167, ($50,000 divided by 12). Here is the formula (I know, some of you are saying, “I hate math,” but this is literally how your bank qualifies you), so let’s do it together. MR + CL + TAX + $100/ MI = TDS x 100 (per cent) MR = monthly mortgage or rent payment CL = monthly credit card or loan payments (add all together) TAX = monthly property taxes or $0 if you are renting MI = gross monthly income Here is an example: A married couple wants to move to a larger home, but they are not sure if they can qualify. The value of their home has gone up considerably since they purchased it, but so have all the other homes in their area, which limits what they can spend on their next purchase. Partner one earns $52,000, partner two earns $26,000, total = $78,000 divided by 12 = $6,500 each month. Their current mortgage payment is $1,970 per month and property taxes are $285 a month. Current debt payments, including lines of credit, are $971 monthly. Here’s what it would look like. ($1,970 + $971 + $285 + $100) divided by $6,500 x 100 (per cent) = 51.17 per cent Clearly, this couple would not qualify with the banks as presented because their monthly debt load is too high, ($971 per month) and it is putting them over the 40 pre cent threshold. How to qualify for more? There are only three ways to get the ratio in line: 1. Add more income 2. Lower debt 3. Consolidate into a new mortgage and spread out the payment to lower the monthly expenses. To find out if this couple could indeed sell and move to another residence, we would have to determine if they had enough equity in their home to consolidate their debt, cover expenses and still have a deposit from the sale to purchase another home. Here is a quick example of a larger monthly mortgage payment with higher property taxes but with no debt, assuming this was paid off with the proceeds of their home sale and keeping the same income. Let’s assume a new mortgage payment of $2,126 per month and new property taxes of $310 per month. ($2,126 + $0 debt + $310 + $100) divided by $6,500 x 100 (per cent) = 39.02 per cent. Viola! Now they qualify. Try this out on your own budget. Having monthly loan payments hinder your ability to improve your situation. If you calculate your TDS and are over the 40 per cent, you probably already feel it financially every month. Why not look at consolidating, downsizing, or finding new ways to eliminate your debt? Talk to your banker. Do it now, before the interest rates go higher. Remember, high interest is the common man’s “silent killer” to their future. Good luck and best wishes, Christine Ibbotson. Christine Ibbotson is a national radio host and author of three finance books, plus the Canadian best-selling book, How to Retire Debt Free & Wealthy. Visit www. askthemoneylady.ca or send a question to info@ askthemoneylady.ca.