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Navigating the mortgage application process can be complex, especially when it comes to understanding the factors that influence your eligibility for a loan.
One of the key aspects to consider when applying for a mortgage is debt service ratios, specifically the Gross Debt Service Ratio (GDS) and Total Debt Service Ratio (TDS).
These ratios provide a clear picture of your financial capacity to manage housing costs and other debts, giving lenders a better understanding of the potential risks of lending you money.
This guide will delve into the importance of GDS and TDS, how they are calculated, and the recommended limits for each.
By the end, you’ll be well-equipped with the knowledge needed to make informed decisions when applying for a mortgage and finding the best solution for your unique financial situation.
This is a set of ratios that help lenders figure out if you can actually afford the mortgage payments with your current income and expenses. The ratios consider your mortgage payment, property taxes, heating costs, and any other debts you might have, like car loans or credit card payments.
Debt service ratios are super important for mortgage qualification, and they’re made up of two parts: the Gross Debt Service (GDS) ratio and the Total Debt Service (TDS) ratio. Lenders use these numbers to see how much you can comfortably spend on a mortgage based on your income and debts.
The great thing is that calculating these ratios is pretty simple. You can do it by hand or use an online mortgage affordability calculator. Knowing where you stand in terms of affordability will help you plan your home finances better and avoid any unexpected surprises.
So, let’s dive in and explore each debt service ratio in more detail.
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The Gross Debt Service (GDS) ratio determines the percentage of your gross household income needed to cover your housing costs. This includes your mortgage payment (both principal and interest), property taxes, heating expenses, and half of your condo fee (if you have one).
A lower GDS ratio is definitely better.
For prime mortgages (those with low down payments or good credit scores), the maximum GDS ratio is 39%. This limit can go up to 50% for mortgages with bad credit.
By knowing your GDS ratio, you’ll get a clearer picture of how much you can actually afford to spend on housing costs. This will help you make a smarter decision regarding your mortgage
Calculating your Gross Debt Service (GDS) ratio is a breeze. Just follow these simple steps to figure out what percentage of your monthly income goes toward housing expenses:
The final percentage shows how much of your monthly income is used for housing expenses, giving you an idea of your mortgage affordability.
Remember, a lower GDS ratio is generally better. Most prime mortgage lenders have a maximum limit of 39%, but some alternative lenders may allow a higher limit of 50%.
The Total Debt Service (TDS) ratio calculates the percentage of your gross household income needed to cover all your debts, not just housing costs. This includes your mortgage payment, condo fee, property taxes, heating expenses, and other debts like car loans, credit lines, credit cards, student loans, and more.
A lower TDS ratio is always better. The maximum acceptable TDS ratio is 44% for prime or good credit mortgages. However, this limit can go up to 50% for alternative mortgages.
To figure out your Total Debt Service (TDS) ratio, follow these steps:
This will give you the TDS ratio as a percentage. The TDS ratio indicates what portion of your income is dedicated to debt repayment. A lower TDS ratio means your debt is more manageable.
Here’s the formula: [[TDS Ratio = (Total Housing Costs + Other Debts) / Gross Family Income]]
Keep in mind that lenders use the TDS ratio to determine how much you can afford to spend on monthly housing and debt repayment.
Now that you’re familiar with gross debt service (GDS) and total debt service (TDS) ratios let’s see how they apply in a real-life situation.
Imagine you and your spouse have a combined pre-tax income of $120,000 without considering taxes, CPP, or other deductions. This translates to a monthly gross income of $10,000.
You’re seeking a mortgage, and your monthly housing expenses are:
Your total monthly housing cost comes to $3,110. Divide this by your pre-tax monthly gross income of $10,000, and you get a GDS ratio of 31.1%.
Since this is below the 35% threshold, you can afford the mortgage and housing costs based on your current income.
Now, let’s check your TDS ratio by factoring in your other debts. Continuing with the example, let’s say you have the following monthly debt payments:
These additional expenses total $1,430 per month. Combined with your housing costs, you now have a total monthly cost of $4,540.
Dividing this by your gross monthly income of $10,000 results in a TDS ratio of 45.4%. This exceeds the standard maximum ratio of 44%, meaning you can’t afford the mortgage loan you’re requesting.
To qualify, you’ll need to lower your TDS ratio. Consider paying off some personal loans, increasing your income with a co-signer, or reducing the requested mortgage loan to bring your TDS ratio down.
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Prime mortgage lenders typically prefer a GDS ratio of 39% or lower.
However, alternative or B-mortgage lenders might be more flexible, considering up to 50% GDS ratios.
A GDS ratio over your lender’s guideline limit indicates that your housing costs are too high compared to your income, making affording that lender’s mortgage difficult.
As a result, your mortgage application might be declined.
For prime mortgage loans, the recommended TDS limit is 44%, while for alternative or bad credit mortgages, it’s 50%.
A TDS ratio above the limit signifies that your combined monthly payments for debt and housing costs, relative to your income, are higher than your lender’s guideline limit.
A higher TDS ratio suggests an increased risk of defaulting on the mortgage, which could lead to your mortgage application being declined.
It’s essential to maintain your TDS ratio below the suggested limit.
Remember that GDS and TDS ratios are guidelines, not strict rules. You may still have options if your ratios are above the recommended levels. approvU can instantly qualify you for alternative mortgage solutions.
Here are a few strategies to lower your ratios:
In summary, understanding the Gross Debt Service Ratio (GDS) and Total Debt Service Ratio (TDS) is essential when applying for a mortgage loan.
These ratios provide insight into your ability to repay housing and personal debts, allowing lenders to gauge the risk of lending you money.
Maintaining a GDS below 39% and a TDS below 44% for prime mortgage options is advisable.
Being aware of your debt service ratios and keeping them within the suggested limits are essential when purchasing a home.
Staying informed about the mortgage process can help you make well-informed decisions, ensuring you obtain the most suitable mortgage solution for your financial situation.