Are you considering applying for a mortgage soon? Before approving your loan, the bank will assess your borrowing capacity by checking your debt service ratios: Gross Debt Service (GDS) and Total Debt Service (TDS).
So, what are these ratios, and why are they important? Let’s break it down and see how they can impact your ability to secure a mortgage.
What is a debt service ratio?
Debt service measures your income in relation to your debt obligations, typically expressed as a percentage known as a debt ratio. This allows lenders, like banks, to quickly evaluate your ability to repay debts.
Essentially, when you apply for a loan, lenders use your debt service ratio to determine how much additional debt you can responsibly take on. Debt service is usually evaluated through two key ratios:
- Gross Debt Service (GDS)
- Total Debt Service (TDS)
Mortgage lenders typically set a maximum GDS ratio of 32% and a TDS ratio of 40%, although acceptable limits may vary between institutions. Furthermore, borrowers with stable incomes and good credit histories may still qualify for a loan even if their ratios exceed these limits. Let’s delve deeper into these concepts.
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Gross Debt Service (GDS)
Gross Debt Service (GDS) is the first calculation lenders use to assess your borrowing capacity. It measures the percentage of your gross income dedicated to housing expenses, which include your mortgage payments, heating costs, and property taxes.
While the general guideline for a maximum GDS ratio is 32%, the Canada Mortgage and Housing Corporation (CMHC) allows for a higher limit of 39%. This means you might qualify for a mortgage even if your GDS exceed the standard threshold in certain circumstances.
How to calculate the GDS Ratio
To calculate your Gross Debt Service (GDS) ratio, follow these steps:
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Add your housing costs: include your total mortgage payments, property taxes, heating costs, and 50% of your condo fees if applicable.
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Calculate your annual gross income: this is your total income before taxes.
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Calculate the GDS ratio: divide your total housing costs by your annual gross income.
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Convert to percentages: multiply the result by 100 to get your GDS as a percentage.
To help you with the calculations, you can use the CMHC online debt service calculator.
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Total Debt Service (TDS)
The second calculation is for Total Debt Service (TDS). Unlike the GDS ratio, this one accounts for all your personal debts, including mortgage payments, auto loans, lines of credit, and credit card balances.
As mentioned earlier, banks typically prefer a maximum TDS ratio of 40%. However, the CMHC suggest that it can go up to 44%.
How to Calculate the TDS Ratio
To determine your Total Debt Service (TDS) ratio, follow these steps:
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Calculate your total debt payments: Add your total mortgage payments, property taxes, heating cost, 50% of your condo fees (if applicable), and the total payments for other debts such as auto loans and credit card.
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Determine your annual gross income: this is your total income before taxes.
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Calculate the TDS ratio: divide your total debt payments by your annual gross income.
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Convert to percentages: multiply the result by 100 to get your TDS as a percentage.
For convenience, you can also use the CMHC online debt service calculator to assist you with the calculations.
Knowing your debt ratio: why is it important?
Understanding your Gross Debt Service (GDS) and Total Debt Service (TDS) ratios is essential when applying for a mortgage, especially if you seek insurance from the CMHC. These ratios have a direct impact on whether your application will be accepted by the lender.
If your GDS or TDS ratios exceed the maximum limits set by the lender or CMHC, you may have difficulty in securing a loan. By knowing your debt ratios beforehand, you can evaluate whether they fall within acceptable limits and make any necessary adjustments to improve your chances of approval if they do not.
High GDS and TDS ratios: what does it mean?
A high GDS or TDS ratio doesn’t automatically disqualify you from getting a mortgage, but it can complicate the approval process.
If your debt ratios are close to or slightly above the recommended maximum limits, having a strong credit history and a stable income may work in your favour. Ultimately, the lender will assess the risk you present, and approval may hinge on reducing the amount of the loan you’re requesting.
If your debt ratios are higher than ideal, consider these options:
- Paying down existing debts can improve your ratios.
- Increasing your down payment can help you make your application more appealing.
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