Reviewing the Real Life Ratio

Lately, I’ve been keeping an eye on the Globe & Mail. I am glad to see more good articles written about house-hold debt. In the past I've written about this topic, buying what’s reasonable versus maximum.

Rob Carrick from the Globe & Mail wrote two excellent pieces on 6 March 2014 and 19 March 2014. In the March 6th piece, entitled “Can you really afford that mortgage? Know your Real Life Ratio”, Rob makes a bold outright statement when he says, "Someone ought to explain the facts of life to the nation’s bankers....Never take a lender’s word for it that you can afford a house." Rob highlights what he calls the real life ratio which accounts for the basic costs of home ownership but also the real world expenses such as education, insurance, and long-term home maintenance. The real life ratio (see attached link, excel sheet) also shifts depending on what stage you are in life including your kids.

In Rob’s second article, entitled “West Coaster making $86,000 can barely afford his modest life,” Rob shares the life of Hamish Telford.Hamish is separated from his wife, has a 7 year old son and a professor of political science who is considered upper middle class living in Abbotsford, BC. Hamish spends over 50% of his net income towards household expenses.  Hamish is hanging and “isn’t looking for sympathy, just some understanding of how hard it is to get by even for a member of the upper middle class.” He is more worried about others, “I can only imagine how stressed the other 95 per cent of the population must feel."

The point of the article was that Hamish had car trouble and needed to spend approximately $1500-$2000 to fix his car and he sadly had trouble doing so. People should think about the Real Life Ratio when considering the home they wish to purchase.

What’s my buying capacity? Maximum versus reasonable

Probably the number one question I get asked as a mortgage broker is “Hey Mark, what’s my buying capacity?” As a first time buyer or even a repeat buyer your buying capacity is mission critical. With my weekly column in the Hudson Gazette and my blog montrealmortgageblogger.com, I’ve received quite a few calls from home owners that are over their heads with mortgage and debt payments. It’s always good for the ego to see our maximum buying capacity, but does it make sense to stretch it that high? I will tell you from several horror stories that I’ve seen the past three weeks, clearer it’s not worth it.  

Your buying capacity is based on a couple mortgage calculations, one in particular referred at TDS or Total Debt Service ratio. Typically all Canadian banks use this calculation. This calculation takes a look at your annual expenses namely school and municipal taxes, home heating, and your personal debt load and is divided by your gross income (combined if you are a couple and a portion of your rental income, if any) multiplied by one hundred. On an insured purchase meaning your putting less than 20% down payment, your TDS can go up to 44%. Depending on the lender a refinance the TDS can range from 40-44% whether you are refinancing conventionally (up to 80% of market value of your home) or insured (85% of market value).

First and foremost if you are buying or refinancing mortgage planning is invaluable. You will not always get that detailed service at the branch-level at a bank. That statement is not intended knock the banks but one needs to be careful and budget conscious. A good mortgage broker can help you establish a plan and keep you on budget. What I mean by that is take a much closer look at that TDS calculation. TDS is a crude ratio and does not take into account a lot of your other annual expenses such as insurance, school tuition for the kids, food, gas, etc. With that in mind you can create a reasonable buying capacity. Lastly, when taking your income into account typically I look solely at base incomes and if appropriate exclude or take an average of your over time, bonuses and commission. I treat those as sugar because they can all disappear or fluctuate tremendously in this economy.

If you have any questions or would like to share a mortgage experience, I’d love to hear from you. Have a great week.