If you’re considering buying a home in Canada, you’ve likely heard the term “debt servicing ratios” thrown around. But what exactly are they, and why are they important for your mortgage application?
What Are Debt Servicing Ratios?
Debt servicing ratios, also known as debt-to-income ratios, are a measure of your ability to manage and repay debt. They compare your total monthly debt payments to your monthly income, giving lenders an idea of how much of your income is going towards debt repayment.
In Canada, there are two main debt servicing ratios that lenders use when evaluating mortgage applications: the Gross Debt Service (GDS) ratio and the Total Debt Service (TDS) ratio.
Gross Debt Service (GDS) Ratio
The GDS ratio looks at your housing costs, including mortgage payments, property taxes, and heating expenses, and compares them to your gross monthly income. This ratio helps lenders determine if you can afford the monthly payments on your mortgage.
In Canada, most lenders prefer to see a GDS ratio of 39% or lower. This means that your housing costs should not exceed 39% of your gross monthly income.
Total Debt Service (TDS) Ratio
The TDS ratio takes into account all of your monthly debt payments, including housing costs, credit card payments, car loans, and any other outstanding debts. It compares these payments to your gross monthly income to determine your overall debt load.
In Canada, most lenders prefer to see a TDS ratio of 44% or lower. This means that your total monthly debt payments should not exceed 44% of your gross monthly income.
GDS Ratio Calculation
To calculate your GDS ratio, follow these steps:
- Add up your monthly mortgage payments, property taxes, and heating expenses.
- Divide this total by your gross monthly income.
- Multiply the result by 100 to get a percentage.
For example, if your monthly housing costs are $2,000 and your gross monthly income is $6,000, your GDS ratio would be (2,000 / 6,000) * 100 = 33.33%.
TDS Ratio Calculation
To calculate your TDS ratio, follow these steps:
- Add up all of your monthly debt payments, including housing costs, credit card payments, car loans, and any other outstanding debts.
- Divide this total by your gross monthly income.
- Multiply the result by 100 to get a percentage.
For example, if your total monthly debt payments are $3,000 and your gross monthly income is $6,000, your TDS ratio would be (3,000 / 6,000) * 100 = 50%.
Why Do Debt Servicing Ratios Matter?
These ratios are important for both lenders and borrowers. For lenders, they provide a measure of risk when evaluating mortgage applications. A high GDS or TDS ratio may indicate that a borrower is overextended and may have difficulty making their mortgage payments.
For borrowers, debt servicing ratios can help determine how much mortgage they can afford. By calculating their GDS and TDS ratios, borrowers can get a better understanding of their debt capacity and make informed decisions about their home purchase.
How Can You Improve Your Debt Servicing Ratios?
If your GDS or TDS ratio is too high, there are a few things you can do to improve it.
Increase Your Income
One way to improve your debt servicing ratios is to increase your income. This can be done through a raise, a promotion, or taking on a side hustle. By increasing your income, you’ll have more money available to put towards debt repayment, which can lower your GDS and TDS ratios.
Pay Off Existing Debts
Paying off existing debts can also help improve your debt servicing ratios. By reducing your total monthly debt payments, you’ll have more room in your budget for housing costs, which can lower your GDS and TDS Ratios.
Lower Your Housing Costs
If your GDS ratio is too high, you may want to consider lowering your housing costs. This can be done by choosing a less expensive home or finding ways to reduce your mortgage payments, such as opting for a longer amortization period.
Conclusion
Debt servicing ratios are an important factor in the mortgage application process in Canada. By understanding what they are, how they’re calculated, and why they matter, you can make informed decisions about your home purchase and improve your chances of getting approved for a mortgage. Remember to keep your GDS and TDS ratios within the preferred ranges to ensure a smooth and successful mortgage application process.
