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There are two different ratios that lenders will use to determine whether you are a suitable individual to take on a mortgage and, if so, the amount you can afford to borrow from them.
These ratios are the Gross Debt Service Ratio (GDS) and the Total Debt Service Ratio (TDS). There are many different affordability calculators that you can find online, but this is the core method used by lenders.
How are the debt service ratios calculated?
Gross Debt Service Ratio:
(Mortgage payments + Property Taxes + Heating Costs + 50% of Condo Fees) / Annual Income
Total Debt Service Ratio:
(Housing Expenses + Credit Card Interest + Car Payments + Loans) / Annual Income
Your target should be to achieve under 32% for the Gross Debt Service Ratio and 40% for the Total Debt Service Ratio when looking at these two separate ratios. However, these are also just guidelines, and some lenders will have different targets. If you have good credit ratings and a history of good lending, you will likely be able to exceed these limits during more prosperous economic times.
Gross Debt Service Ratio (GDS)
When calculating your GDS, your potential lender will try and figure out the amount of your income each month you will be putting towards paying off your mortgage to purchase a partial property. For example, they may conclude that you need to pay $2,000 per month in mortgage payments. On top of this, they will also add the property taxes, costs of heating the property, and 50% of the condo fees if these are applicable.
Once the above is calculated, the lender will divide this by your annual income to determine how much of a cost this property will be as a percentage of your total income. This is essentially a check for them to make sure that you’re not over-leveraging yourself, and there is plenty of room for movement if you were to begin earning less or have a sudden increase in expenses. In short, it is to make sure they will continue to receive payment for lending you the money for your property. If this percentage is calculated at less than 32% and you don’t have any worrying history of bad credit, then you can likely rest assured that you will be approved for the mortgage.
Total Debt Service Ratio (TDS)
The TDS ratio is similar to the GDS ratio. They take the same calculation they put together for the top line of the calculation and then add some further monthly payments you might incur. These are commonly credit card bills, any car loans etc. This is why owning a car outright can be really beneficial for obtaining a mortgage, as you will be surprised at how much it can impact your affordability.
This figure is then divided by your gross annual income (i.e., before income tax). The industry standard here is to approve anything below 40%, and if you achieve this, the lender knows they can likely trust you to make all of your monthly payments and be on a good path to pay off your mortgage’s entirety.
Over the Ratio Limit?
There are several options here. It could be that you would be better suited to looking into more 2nd tier lenders, who are generally a little more flexible with their application/approval process. However, while you may be able to be approved, your overall interest payments will be higher, and you will pay more overall for your property.
The next best option would be to save a little more for the deposit on the property you’re looking for. This will adjust the total you’re looking to borrow from the lender and reduce the monthly payment aspect within the ratio calculation. This can reduce the overall percentage. Depending on your situation (property value or deposit amount), this may not make a huge dent in the outcome, though.
If the above two options don’t suit, then try and look towards eliminating some debt. This can often have a bigger impact upon the industry ratios than simply saving more of a deposit. Paying off a $10k car loan can often impact the calculation due to the significance of monthly payments more than increasing your deposit by $10k. However, it is always recommended to use the calculations and see the best option for you.
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