Lending institutions such as banks and trust companies use two simple rules to determine how much you can afford in monthly expenses for housing including your mortgage payment:
Gross Debt Service (GDS) Ratio: The first rule is that your monthly expenses for housing can not be more than 32% of your gross monthly income. Your monthly expenses for housing include:Principal mortgage payment Interest on the mortgage Taxes – property Heating
If applicable, half of the monthly condominium fees
These expenses are known as PITH for short. Lenders add up these housing expenses to determine what percentage they are of your gross monthly income.
Total Debt Service (TDS) Ratio: The second rule is that your total monthly debt load should not be more that 40% of your gross monthly income. This includes housing expenses (PITH) and other debts such as car loans and credit card payments. Lenders add up these debts to determine what percentage they are of your monthly gross income.
This only leaves 8% (40%-32%) for other debts. If the difference between your GDS and TDS is greater than 8% then the percentage allowed for housing expenses will be lower by the same amount.
Keep in mind that most homebuyers keep their debt ratio comfortably below the maximums prescribed above. The lower your debt load, the more affordable will be your home and lifestyle.
The Down Payment: If you have a down payment of 25% or more, you may qualify for a conventional mortgage loan that does not require mortgage loan insurance. A minimum down payment of 5% is required for a high ratio mortgage. A down payment of less than 25% requires mortgage insurance.