How Lenders Set Mortgage Amounts

Many factors influence the mortgage amount, including the following:

• Size of mortgage requested
• Type of property
• Property Use
• Tenancies
• Financial Means of the Borrower
• Experience and Credibility of the Borrower
• Availability and Timing of Funds

While the above items and more influence the mortgage availability and amount, the two most important formulas used by lenders are the Loan to Value and the Debt Service ratios.

Loan to Value Ratio (LTV)

This ratio compares the value of the property, as determined by the Lender, to the amount of the mortgage. This determines the maximum loan amount. The formula is:

LTV = Mortgage/Value of Property

Example: $650,000 / $950,000 = 0.68, or 68%

Typical LTV ratios change with the market and with the state of the economy. For residential properties, the Canada Mortgage and Housing Corporation (CMHC) will allow higher LTV ratios than normal because it insures the loan. However, they charge a premium of 1.75% to 4.50% for the service, an amount that some borrowers feel is too high.

Debt Service Ratio (DSR)

The other term used for this is Debt Coverage Ratio (DCR). This ratio reflects the difference between the Net Operating Income (NOI) and the loan payments (including both principal and interest). The formula is:

DSR = Net Operating Income/Annual Debt Service (principal and interest)

Example: $75,000 / $45,000 = 1.67

This is used to determine the Lender’s margin of safety in a loan. Most Lenders require a minimum DSR of 1.1 or higher. The lower the DSR, the lower the loan amount that a Lender is usually willing to grant.

In order to appease the Lender when applying for a loan, it is a good idea to include the math that goes into the DSR in your application. These items include:

• vacancies and bad-debt allowance
• property management fees, even if outside property managers are not involved
• maintenance reserve
• additions or adjustments to Income and Expense Statements received from the vendor, as these are traditionally incorrect.