For most families, a mortgage is the largest amount of debt you’ll incur in your lifetime. With home prices reaching the stratosphere in many housing markets nationwide, homebuyers are taking on larger mortgages than ever before.
A mortgage represents a lot of money, so mortgage lenders do their homework before approving your loan. Lenders use debt service ratios when deciding whether to approve your mortgage application. With the federal government tightening mortgage rules over the past several years, maintaining healthy debt service ratios is crucial.
Gross Debt Service (GDS) Ratio
The Gross Debt Service (GDS) ratio measures the portion of your take-home pay needed to cover your monthly housing costs. Housing costs include your mortgage payment, property taxes, heating bill, and 50 per cent of your condo fees (if applicable). You should strive for a GDS ratio of 32 per cent or lower.
Calculating Your GDS Ratio
Mortgage lenders across the board use the same formula for determining your GDS ratio.
GDS Ratio Formula:
GDS = (PITH + ½ Condo Fees)/Monthly take-home pay x 100
P = Mortgage Principal
I = Mortgage Interest
T = Property Taxes
H = Heating
For example, If you have a monthly mortgage payment of $1,450, property taxes of $250, monthly heating bill of $110 and monthly take-home pay of $6,000, your GDS will be:
GDS = ($1,450 + $250 + $110) / $6,000 x 100 = 30.17%
Since your GDS ratio is below 32 per cent, you should have no problem qualifying for a mortgage (as long as you have a decent credit score).
Total Debt Service (TDS) Ratio
The TDS ratio is like the GDS ratio’s older brother. The TD ratio still includes your monthly housing costs (your monthly mortgage payment, property taxes, heating bill, and condo fees), but it goes a step further by looking at how much debt you pay on a monthly basis. Monthly debt includes car loans, credit cards, lines of credit, and student loans.
Calculating Your TDS Ratio
Again, all mortgage lenders use the same TDS ratio when determining whether to approve your mortgage.
TDS Ratio Formula:
TDS = (PITH + ½ Condo Fees + Monthly Debt Payments)/Monthly take-home pay x 100
For example, if you have a monthly mortgage payment of $1,450, property taxes of $250, monthly heating bill of $110, monthly car loan of $500 and monthly take-home pay of $6,000, your TDS will be:
TDS = ($1,450 + $250 + $110 + $500) / $6,000 x 100 = 38.50%
Since your TDS ratio is below 40 per cent, you shouldn’t have any problem affording your home on a month-by-month basis.
As you can see debt servicing ratios go a long way in determining whether mortgage lenders will approve your loan. While debt service ratios are important, they aren’t the only factors lenders consider. Other factors include your credit score and the loan-to-value (LTV) ratio. By saving for a larger down payment and boosting your credit score, you can help better your chances of your mortgage application being approved.