Mortgage Bite #2 - Helping You Understand Mortgages - What are "Debt Service Ratios"?... and how do they affect what I can qualify for?

Author: Shea Stoney Mortgage Solutions | | Categories: First Time Home Buyer Mortgages , Mortgage Broker , Mortgage Down Payment , Mortgage Rates British , Mortgage Refinance , Mortgage Renewal , Mortgage Services , Rental Property Mortgages

Mortgage Bite #2

Debt Service Ratios

In the last Blog, we looked at why lenders care about the “Loan-to-Value” (LTV) measurement in a mortgage application. It is a constraint put on the maximum amount that can be borrowed as a mortgage. The main concern to the lender is the level risk that any given LTV poses to the lender should the borrower default on their mortgage.

Lenders have other lending constraints as well. In this Blog we’ll look at the two “Debt Service Ratios” that lenders use to limit their risk, GDS and TDS.

GDS – Gross Debt Service Ratio

The GDS in simple terms is some of the costs of owning a home as a percentage of the gross income of the borrower.

Depending on the type of lender, the GDS ratio can vary anywhere from 39% to 60%.

  • Prime lenders (banks and credit unions) – Max GDS is 39%
  • Alternative lenders – Max GDS is 60%
  • Private lenders – No Maximum! 60%

The Home Ownership Costs that go into the “Gross Debt” are:

  • The monthly Qualifying* Mortgage Payment (Principal and Interest)
  • The annual Property Taxes (divided by 12 months)
  • A monthly ”Heat” allowance, (general utilities – usually about $100 / mo.)
  • The monthly Strata fees, but it’s only HALF of the cost!

*The QUALIFYING mortgage payment will be higher than the actual mortgage payment. This is the “Stress Test” payment, which is based on an interest rate that is at least 2% higher than the rate you are actually getting.

Your “Gross Income” consists of the total of any of the following:

  • Employment or Self-Employment Income
  • Dividends from your own corporation
  • Pension Income
  • Child Tax Benefits
  • Rental Income (usually only 50% though, and it’s actually a bit more complicated than that.)
  • Part time employment income
  • Alimony
  • Disability Income (some caveats with this though.)

Income that doesn’t usually count toward your Gross Income are things like:

  • Employment Insurance
  • Retained earnings from your own corporation
  • RRSP or RRIF withdrawals
  • One time profits from the sale of investments or property

GDS = (Qualifying Mortgage Payment + Property Taxes + “Heat” + ½ of Strata Fees)

Gross Income

TDS – Total Debt Service Ratio

The TDS in simply the addition of other monthly debt obligations to the Home Ownership Costs that are used in the GDS calculation as a percentage of the gross income of the borrower.

Depending on the type of lender, the TDS ratio can vary anywhere from 39% to 60%.

  • Prime lenders (banks and credit unions) – Max TDS is 44%
  • Alternative lenders – Max TDS is 60%
  • Private lenders – No Maximum! 60%

What lenders are really saying is, even if your at your limit with the home ownership costs, we’ll let you have other debts as long as they aren’t another 5% of your income added on.

The “Other Debt” Costs that go into the “Total Debt” are things like:

  • Car loan payments
  • Credit Card payments – lenders use 3% of the card balance and not the minimum payment
  • Rental property costs – lenders use a variety of methods of calculating the positive or negative cash flow of a rental property and it’s usually not what the actual cash flow is.
  • Payments on secured and unsecured lines of credit
  • Student loan payments
  • Alimony and child support
  • “Shelter Allowance” if you’re living rent free with someone and you need a mortgage for a rental property. Lenders factor in the probably that you won’t be able to live rent free forever.
  • Basically, anything that appears on your credit report, (except your monthly cell phone bill.)

What Do the GDS and TDS ratios Mean for You?

One of the key takeaways you will want to know is how your GDS and TDS can limit the amount you can borrow as a mortgage.

Whether you are buying a property, refinancing or moving your mortgage to another lender, one of the “affordability” tests that lender use looks at how much of your income is going toward servicing your home ownership expenses and other debt obligations.

We can see then that the amount you can qualify to borrow is not only limited by the LTV (Loan-to-Value) as discussed in the last Blog, but also the GDS and TDS.

Not all GDS and TDS ratios are the same though. A bank may decline a mortgage application because the GDS and TDS are over their limits but the “alternative” lenders have much higher limits.

Many homeowners have turned to alternative lenders in recent years because of the high cost of housing and now rising interest rates, (i.e. qualifying mortgage payments.) Mortgage brokers have exclusive access to these alternative lenders since they don’t have branches that you can walk into. If you find yourself constrained by the GDS and TDS at a bank, you can talk to your mortgage broker about the “alternatives”.