Learning more about debt service ratios.

Debt seems unavoidable these days and many Canadians find themselves facing significant debt, regardless of their stage of life.  Some factors that may impact debt levels are inflation, increased educational requirements, lower-earning jobs, and global recessions. Debt and money stress are normal for many Canadians, including those looking to buy a new home. 

Now that we understand the unavoidable reality of debt for many Canadians, we should acknowledge the silver lining. The inevitability of debt means that we are not necessarily barred from homeownership simply because we are facing debt. Many mortgage brokers will put consideration on a variety of factors, including the topic of today’s post, debt ratios.

What are debt service ratios?

There are two different categories of Debt Service Ratios that your mortgage broker or direct lender will calculate during one of your meetings. The first one is your Gross Debt Service Ratio (GDS) and the other is your Total Debt Service Ratio (TDS). These ratios will help the lender determine what you can afford on a monthly basis and will also inform the lender of the risk factors associated with lending to you.  As you might have expected, the lower this ratio is, the better.

Gross Debt Service (GDS) Ratio

Your GDS Ratio looks at the portion of your income needed to cover your housing costs on a monthly basis. Specifically, your GDS calculates how much of your gross monthly income is being used to cover your your mortgage payments, property taxes, and heating. Your GDS should be below 39% of your gross monthly income.

 

Total Debt Service (TDS) Ratio

This is the ratio that many homebuyers find themselves worried about.  Your Total Debt Service Ratio includes your housing costs but also factors in your other debt obligations. These other debts might include loans (auto, student & consolidation), lines of credit, credit cards, child support and alimony.  TDS should be less than 44% of your monthly income. 

 

How do GDS and TDS impact my mortgage application?

Like your credit score, employment, and your down payment, your GDS and TDS helps the lender determine what you can afford. Everyone has unexpected expenses from time to time and these ratios will help the lender ensure that you can afford your payments. Your mortgage broker will review your GDS and TDS with you to ensure it falls within an acceptable threshold.

What if you’re not below 39% GDS and 44% TDS for whatever reason? Fear not! The industry standards are guidelines lenders follow, but there are exceptions in some situations. It is possible to gain mortgage approval from lenders while sitting above these standards but you may end up paying a higher interest rate on your mortgage.  If you’re worried that your GDS and  TDS is high, you are not alone. If you’d like to chat about the possibility of obtaining a mortgage when you don’t meet the standard debt ratios guidelines you should speak to a mortgage broker.

Okay, how can I improve my debt service ratios?

Your debt service ratios can impact the mortgage amount you will qualify for. This can, unfortunately, put your dream home just out of reach until you can improve these ratios. The best way to improve your debt ratios is to focus on two things: your consumer debt and your income. By making more money, or decreasing your debt obligations, you will improve your ratios. This will increase your chances of being approved for the mortgage amount you are looking for.

Increasing your income:

As both your GDS and TDS is a percentage of your income, your debt ratios will naturally be lower the higher your income is. Increasing your income can be a bit more challenging in the current climate. There are a couple ways to improve this. A great way to bring more income is to engage in a side hustle, whether it be tutoring online, delivering papers or even creating online content (though there is no guarantee of reliability for this one).  It’s important to note that your side hustle income has to be declared with CRA for a minimum of 2 years in order to be included in the debt ratio calculations.

Another way to improve the GDS and TDS for your mortgage application is through the purchase of an owner-occupied rental property. This topic may need more context so you can find more information about it here. The short answer is that you can add up to 50% of the rental income of the second unit to your income for qualification purposes. This may change the type of property you are considering, but might be an option where you are unable to improve your GDS/TDS directly.

Pay down your debt

The other, more common, option to improve your total debt service ratio is to pay down your debt. This option will be much more accessible and will yield many more benefits than trying to increase your income. Consumer debt is the debt that keeps many of us awake at night, but depending on where you are, it can be the easiest managed.

If you have assets or savings, you will benefit from paying down your debt. Not only will it improve your debt ratios, but you will also reduce the amount of interest you are required to pay. Paying down debt can be tricky in many situations. By working with a mortgage broker, you will understand what you need to prepare to be approved for a mortgage.

If you are considering buying a home and want to discuss your debt ratios or brainstorm on ways to lower them feel free to contact me! We can work to build a plan to prepare you for homeownership, and help you build a stronger financial future. You can give me a call at (705) 333-4338, or get in touch with me here!

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