Mortgage lenders must determine whether a mortgage loan is adequately secured by the property, and whether the borrower has the financial capacity to make the mortgage payments. To do this, they calculate and set upper limits on three ratios( the indicated upper limits are typical for what are called ”conventional first mortgages”)
Loan – to -Value ratio=(principal amount of the loan)/(Lending value of the property) *100%≤ 75%
The 75% maximum for this ratio means the borrower’s minimum down payment is 25% of the “lending value”. The lending value is the lesser of the purchase price and the market value as determined by a certified appraiser.
CMHC normally restricts debt service ratios to 35% (GDS) and 42% (TDS).
Gross Debt Service Ratio (GDS)=(Total monthly payments for mortgage, property taxes and heat)/(Gross monthly income)*100% ≤ 35%
Total Debt Service Ratio (TDS)=(total monthly payments for mortgage, property taxes, heat and other debts)/(Gross monthly income)*100% ≤ 42%
A borrower must qualify on all three ratios. The upper limits for GDS and TDS ratios vary somewhat from one lender to another. Depending on the lender, the maximum GDS ratio can range from 30% to 35% and the maximum TDS ratio from 37% to 42%.
You can exceed the normal 75% limit on the loan-to-value ratio for a “conventional mortgage”, but you are required to purchase mortgage default insurance if you go over the normal 75% limit. The lender treats the insurance premiums as part of your monthly debt payments when calculating the GDS and TDS ratios.
Alice and Matthiew would like to know the maximum conventional mortgage loan for which they can qualify at RBC bank. RBC bank has upper limits of 35% for GDS ratio and 42% for TDS ratio. At this moment they have $240,000.00 saved for a down payment on a home. Their gross monthly income is $18,500.00 and at the present time they have 20 more monthly payments of $540.00 remaining on their car loan.
Questions:
- If the estimated heating costs are $300.00 per month and the property taxes are $420 per month, what maximum monthly mortgage payment do the GDS , TDS and loan –to-value ratios permit?[ Hint take the minimum value that can satisfy all these 3 constraints ] [ 2 marks]
- What is the maximum mortgage loan for which they can qualify? ( use a 25-year amortization and an interest rate of 1.56% compounded semi-annually for a five year term. (Rounded to the nearest $100 (the loan )and use this rounded value for the rest of your case study)[ 2marks]
- Based on their savings for the down payment and the maximum loan from part (2), what is the highest price they can pay for a home? (Rounded to the nearest $100)[ 2 marks]
Suppose that they took that maximum loan and they signed a mortgage contract with RBC bank at 1.56% compounded semi-annually for the first five years and monthly payments for 25 years.
a. Find the regular monthly payment for the first 5 year term ( rounded up to the dollar).[ 2 marks] For all other calculations round to the nearest dollar
b. Find the total interest (total cost of financing).[1 mark]
c. Show the first three lines of the amortization schedule.[ 2 marks]
d. Find the outstanding balance after 3 years.[ 1mark]
e. Find the total principal and the total interest paid in the first 3 years. [2marks]
f. Calculate their equity after 3 years [ 2mark]
g) After 3 years, interest rates drop to 1.32% compounded semi-annually. There is a penalty of 3 months’ interest on the outstanding balance for early repayment. Does it pay to refinance? [ 3marks]Do not
h). If the penalty is based on the interest rate differential (difference between the contractual interest rate on the loan and the current interest rate) , calculated as :
Penalty = (outstanding loan balance) × IRD × (term remaining in payment periods) Does it pay to refinance? [ 3marks]
Sample Solution
