Debt Ratio, Loan to Value and say what what?

Memories before Responsibilities

or 

How I finally Learned What Debt Ratio Meant. 

I remember when I was a young boy, lying outside on the back lawn, looking up at the stars and thinking how cool it would be to have a tent.
Then I was a young man, lying in the back of my car, looking up at at the stars through the sunroof and thinking how cool it would be living in a house.
Then, when I was a slightly older man, lying in my bed in a house with 4 other roommates and thinking how cool it would be to have my own house, one without roommates.

His Retro Winnipeg Jets shirt only got him so far...

But I had no idea how to start. I saw a 'For Sale' sign on a nice house, called the realtor and quickly hung up after she told me how much it was. I found out that the first thing I needed to do was find out how much of a house I could actually afford. I realized that I should be looking at something a bit smaller, like a stand-alone carport or maybe fulfill that childhood dream of getting a tent.

Discouraged, I began to learn the backside of home purchase; what a mortgage was, why that interest rate thing I continually heard about on the news was so important. How could someone on my relatively low income ever afford to live without roommates? So I made an appointment with my bank's financial consultant.


You know that feeling you get when you have to go purchase a set of tires and the dealer asks you such questions like 'what size rims you have?' or 'how do you plan on paying for these?' and you are like 'I just want some friggin' tires that don't cost an entire paycheck.'? Well, that's what I felt like when I had to talk to a banker the first time about getting a mortgage. With the aid of his computer, he started to plug in numbers that (to me) were entirely magical; he would talk about the percentage rate and my loan to value ratio and i would just stare at him with a glazed look and nod until he was finished.

I basically entrusted him to do right by me and I like to believe he did. He's a great guy; went down to Nashville to record a CD with his buddies that I think never panned out. He got conned by the glitz and the glamour of fulfilling his dream, hired a producer that took all of their money and kept delaying the final product. I don't know if that CD was ever finished. So rule #1 - don't get conned by the glitz and glamour of owning your own home. I did buy a house, the cheapest one that was listed in the realty guide. It was a start; I was in my own home, albeit one without a built-in media center or a secret bookcase/stairway (which is on my dream house wish-list).

And it leads to another set of bookcases!

So what does this have to do with you?

With the help of someone you trust, figure out how much money you can actually afford to spend on a monthly mortgage payment without sacrificing a few of your other bills, like heat, food, student loans and/or credit cards. This is what a lender considers your Debt Service Ratio (or DSR), a number that they factor in when deciding on exactly how much of a mortgage they are willing to give you. It might be $400,000 it might be $40,000. It will be up to your income and savings to make that number work for you.


The second leading factor that lending institutions consider is your Loan To Value ratio (or LTV); here in Canada it's set at 95%, meaning that most lending institutions will only lend you 85% of a property's appraised value. The Canadian government, in an effort to avoid the housing crisis that hit the United States effectively stated that a bank can only risk 95% of the value of the house, it will never give out a mortgage for more than a house is appraised at.

To keep it bluntly, if you want to purchase a house that has been appraised at $100,000 most Canadian lenders will only grant a maximum mortgage of $95,000 - you will have to come up with the difference through some other options.

"Hi Mom?"

But, if you want to purchase a $100,000 house and you only need to borrow $50,000, the LTV ratio is now only 50%.  Most lenders will have no problem assigning a mortgage based on the lesser of the risk of foreclosure.

Finally, let's hint about talking about your credit score, or in fancy talk - your Beacon Score. Don't ask me why it's called that, I'm just blogging here.

Your credit score is something we are warned about since high school when most of us don't have jobs, credit cards and rely on our parents to pay our cell phone bill. We are told to get into 'the system' quickly by applying for any type of credit we can get - Home Depot, Sears, Esso. They all have a version of a credit card and the only thing they ask in return is that you use their cards to 'borrow' money from them, which you don't have to pay back right away. Most 'only' charge you 20-30% interest on your balance. Credit is a slippery slope that best be left to it's own blog entry.

In short, lending institutions want to see that you have 'borrowed' money from somewhere and 'paid it back'. That is your credit score. The more companies you have 'borrowed' and 'paid back', the better your score.

That's it.  Apply for credit, use it, make payments, your credit/beacon score goes up.

"For the last time, Einstein, it's not rocket science,
it's modern banking."

Lending institutions think "Hey, this is someone who will pay us back this large amount of money we are thinking about giving them." One of these institutions calls the mortgage broker, the papers are signed and next thing you know, NEW TENT!

"Get their mortgage broker on the phone! We have a deal!"