Defining Some Important Terms

Knowing and understanding these terms help you to speak the same language as your lender. They help you to succeed at decoding the requirements of your lenders, and offer you different insights into what you need to change in order to make yourself more appealing to them.

Debt Coverage Ratio – DCR
The properties in your portfolio need to cover their debt at a 1.1-1.3 or more ratio, using a standard formula of Income over Expenses. For example, your mortgages, heat, utilties, condo fees, insurance, taxes = $15,000 a year, and your rental income = $20,000 then 20,000/15,000 the DCR is 1.333

Banks will differ on what they want to see in this ratio, and will use different variables for the following.
o   Standard Expenses used in Calculation (Utiltities, Taxes, Insurance etc. will depend on the lender)
o   Amortization
o   Principal & Interest Calculation

This also helps keep you in a good cash-flow situation.

If you already have a rental property, then you need to complete this DCR Calculator Master Spreadsheet in order to define what is your current DCR on your existing portfolio. If you do not have a rental property, then put in the numbers for a property that you are considering purchasing, and see if your property fits in the 1.1-1.3 range.

**If your current portfolio does not meet these requirements, then be prepared to brainstorm some ways to increase your income and decrease your expenses in order to do that.

Gross Debt Service Ratio
This is the percentage of your income needed to pay all monthly housing costs, which include your mortgage, property taxes, heat and 50 per cent of your condo fees, if applicable. The majority of lenders abide by a general standard of 32 per cent. This means your GDS should be lower than that to qualify for a mortgage.

Calculating your GDS – Add all of your monthly housing-related costs (principal, interest, property taxes and heating) calculated on an annual basis), then divide the total by your gross income. The sum is then multiplied by 100 to give your GDS ratio.

Use the CMHC Debt Service Calculator to find your own Gross Debt Service Ratio. What is your GDS?

Total Debt Service Ratio
Your TDS is calculated next. The calculation is very similar to that of the GDS, except all of your monthly debts are taken into consideration. This includes car payments, credit cards, alimony, and any loans. The industry standard for TDS is 40 per cent.
Calculating your TDS -In addition to the total monthly housing expenses, you now must add payments such as credit cards and car payments. Once you have added all of these expenses, divide the figure by your gross income, multiple by 100 and the result will be your TDS

Use the CMHC Debt Service Calculator to find your own Gross Debt Service Ratio. What is your TDS?

Usually lenders will use two different methods to calculate your income from your exisiting real estate portfolio – Rental Offset or Rental Add Back. Depending on which method they use, it can be more challenging for you to get another mortgage with them. Your mortgage broker or banker can help you with this.

Rental Offset

Rental offset is the percentage of rental income that a lender will allow a borrower to deduct from their housing expenses to help them qualify for a mortgage.

Typically the offset is in the range of 50-80% with some lenders allowing up to 100% on conventional mortgages.

GDS (with Rental Offset) = [PITH – (Rental Offset x Rental Income)] / Borrower’s Income

PITH = Principal, interest, property taxes, heat, and 1/2 of condo fees. PITH generally takes into account housing costs from all the borrower’s properties.

Example: Ted earns 80,000 annually, and has a rental property with $1450 rent where the tenant pays all the utilities. The taxes are $3600 a year, and the monthly insurance is $80. The mortgage payment is $700 per month. Let’s assume that the lender uses a 90% of the rental income.

GDS (with Rental Offset) =( [90%*$1450]– [$700+(3600/12)]*12)/80000

Using this method the GDS added to the borrower = 4.575%

Rental Add Back

Rental add-back is also defined as the percentage of rental income that a lender will allow a borrower use to help them qualify for a mortgage. Add-back ranges from 50-100% on conventional mortgages but rather than deducting this amount from housing costs, it is added to the borrower’s income.

GDS (with Rental Add-Back) = PITH / [Borrower’s Income + (Rental Add-Back x Rental Income)]

Example: Let’s use the exact same numbers for Ted, except we will calculate using the add back method

GDS (with Rental Add-Back) = [$700+(3600/12)]*12/ [80.000 + (.90*1450*12)]

Using this method the GDS added to the borrower = 12.5%

Secured vs Unsecured Lines of Credit

An an additonal complication to calulating GDS and TDS has to do with the type of product that you use to borrow money. This can effect your ability to purchase because it effects these calculations.

For example, let’s say you have a secured line of credit at a 3.15% interest rate and an unsecured line of credit at 5% interest rate. If you borrow $20,000 from each the way a lender see’s it is differently.

The secured line of credit looks like this ($20,000 X .0315)/12 = $52.50 per month

The unsecured line of credit looks like this ($20,000 X .03) = $600 per month

The lender will usually take 3% of the balance as the unsecured line of credit as the monthly payment, which effects your GDS and TDS.

Amortization

Amortization is the process by which mortgage principal decreases over the life of a loan, typically an amortizing loan. With each mortgage payment that is made, a portion of the payment is applied towards reducing the principal, and another portion of the payment is applied towards paying the interest on the loan. An amortization schedule, a table detailing each periodic payment on a loan, shows this ratio of principal and interest and demonstrates how a loan’s principal amount decreases over time.

You can still obtain 30 year amortizations on rental proeprties at the time of writing this module, but it is becoming more challenging to find lenders that will go above 25 year amortization on rental properties.

Whenever you get the chance, always take a higher amortization over a lower one. If you would like to pay off the mortgage faster just make sure to ensure that your pre-payment terms of the mortgage allow you to contribute more each month as a principal payment, as if you went with a lower amortization.

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