Mortgages: The importance of the GDS and TDS debt ratio

If you’re planning a major purchase, such as a home, it’s essential to know your debt ratio. Your bank may refuse to grant you a mortgage if it deems that you don’t have the capacity to repay your loan. How does the bank make this decision? By calculating your GDS and TDS debt ratios and analyzing the results. In this article, we explain the Gross Debt Service Ratio (GDS) and the Total Debt Service Ratio (TDS).

The debt ratio is a measure of the weight of your debts in relation to your income. It’s also known as the debt-to-income ratio. The aim of this measurement is to find out whether you have the capacity to repay a loan. So, every time you want to take out a loan, the lender calculates your debt ratio.

Specifically, for a first-time homebuyer, the debt-to-income ratio calculates the annual income required to make mortgage payments, plus other debts (if any). From another angle, the debt ratio calculates whether you have the capacity to make the mortgage payments on a home you’re considering, with your current income.

Lenders use two debt ratios: the Gross Debt Service Ratio (GDS) and the Total Debt Service Ratio (TDS). Here’s how to calculate them…

To calculate your Gross Debt Service Ratio (GDS), add up your mortgage payments, property taxes, heating costs and 50% of condo fees (if applicable). Then divide this number by your annual income. Ideally, this ratio should be less than 32%.

To calculate your Total Debt Service (TDS) ratio, you need to add up your housing expenses (as in the GDS ratio),home insurance, credit card interest, car payments and other loans (student loans, personal loans, etc.). Then divide this number by your annual income. Ideally, this ratio should be less than 40%.

As a general rule, you should obtain a ratio of less than 32% for the Gross Debt Service Ratio (GDS) and 40% for the Total Debt Service Ratio (TDS). Your ability to repay your debts is considered excellent, and you should have no difficulty obtaining a mortgage.

However, these are guidelines and some lenders have different objectives. Even with a higher debt ratio, you can still get a mortgage, depending on your personal and financial situation.

For example, if you have a good credit rating, a stable income and a good credit history, most borrowers will accept higher ratios, up to the CMHC limits (39% for the GDS ratio and 44% for the TDS ratio).

However, the closer your debt ratio approaches 40%, the more of a risk you pose to lenders. You may have difficulty making your monthly payments. As a result, lenders may refuse you a mortgage or car loan with this level of debt.

In this case, you have several options. First, you can turn to second-tier lenders. These are generally a little more flexible in their application and approval process. However, even if you can be approved, your interest payments will be higher and you’ll pay more for your property.

Another option is to save more to increase your down payment. This will lower your monthly payments in the debt ratio calculation. Depending on your financial situation and the property you’re interested in, however, this may have a limited impact.

Often, the best option is toeliminate your debts. In fact, paying off your debts can often have a greater impact on your debt-to-income ratio. For example, paying off a $10,000 car loan can often have a greater impact than increasing your down payment by $10,000. Why? Because of the importance of monthly payments in mortgage approval.

That said, we recommend that you use calculation tools to find out the best option for you.