I know you’re excited to see all the best mortgage rates on the internet. Maybe you’ve even narrowed down your home search to your dream home, and you’re about to go apply for a mortgage. If you haven’t already, you should use a mortgage affordability calculator to see how much you can afford and feel prepared for your application.
Mortgage lenders care about more than just how high your income and credit score is. They also care about how much debt you’re currently carrying. Giving someone too much debt, even if they have a good income, can cause problems if something happens to them or their job. The new mortgage rules have also added to the difficulty of getting approved.
There are two ratios that mortgages lenders use to determine if you qualify for a mortgage. These debt ratios give the lender an idea of how much debt you already have, and if taking on more debt would be a good idea. The more debt you already have, the less likely a lender will agree to pile more on you.
The Gross Debt Service (GDS) and Total Debt Service (TDS) ratios are guidelines, not hard and fast rules. If you fall outside of an “acceptable” range, lenders may still approve you based on the rest of your application, your future potential income, and other factors.
Gross Debt Service
Your GDS is calculated by dividing all of your monthly housing costs by your income. Your monthly housing costs include things like your mortgage payments or rent, heating and air conditioning, taxes on the property, and 50% of condo fees if you live in a condo. The income you use is your pre-tax income.
Bob and Samantha have been living in Toronto for a decade in a condo they bought in 2008. They have a combined annual household income of $120,000, are currently paying $1900/month for their mortgage, with $475/month in condo fees, and average $60 for heating. Their GDS calculation would look like this:
($1900 + ($475 × 50%) + $60) ÷ ($120,000 ÷ 12) = 21.98%
Randy has never owned a home before. He has an annual income of $40,000 and rents a studio apartment for $1200/month. His utilities are covered by his landlord, so he doesn’t have any more related housing costs.
$1200 ÷ ($40,000 ÷ 12) = 36%
Most financial institutions use a GDS of 32 – 35% as acceptable. Bob and Samantha are in a great position according to their GDS, while Randy is just outside. But, since GDS is only a guideline, none of them would be disqualified from getting a mortgage – yet.
Total Debt Service
The GDS is calculated only with housing costs, but the TDS factors in all your debts as well. This includes car loan, student loans, credit card debt, and lines of credit. If you borrowed from your RRSP to help bolster your down payment, that should also be included.
The calculation for you TDS looks like this:
All your monthly housing costs + all your other monthly debt payments ÷ your monthly income
Bob and Samantha had a great GDS, but they are paying $600 a month on their credit cards, are whittling down their student debt with $1000/month, and have car payements that total $800/month.
Their TDS looks like
($1900 + ($475 × 50%) + $60 + $600 + $1000 + $800) ÷ ($120,000 ÷ 12) = 45.98%
Randy has no debt. He started working straight out of high school and takes public transit to work. His TDS looks like:
$1200 ÷ ($40,000 ÷ 12) = 36%
It hasn’t changed because he has no debts.
The acceptable TDS limit is 42%. Bob and Samantha live in an affordable condo, but because of their other large debts, their TDS exceeds acceptable limits. Randy actually falls well below the 42% figure, even though he was above the 35% figure with his GDS.
Taking both of these numbers into account, they would likely not get approved for mortgages that are as much as or higher than their current monthly payments. Bob and Samantha have far too much debt, and Randy doesn’t have enough income. Smaller mortgages that reduced their total monthly payments would bring their ratios within acceptable levels, as would increasing their income – however, both of those options can prove difficult. Randy is in an especially trying situation as he is a first time homebuyer, and home prices are high. The easiest way for him to lower his potential mortgage payments would be to move to a more affordable city. A good option for Bob and Samantha would be to consolidate their debts.
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