How Much Can I Afford? Mortgage Debt Ratios
Are you ready to go out and buy a home, and you’re curious how much you can afford? This is where mortgage debt ratios come into play. In this article, we’ll look at the two mortgage debt ratios lenders care so much about.
Gross Debt Service Ratio
The first debt ratio that lenders care about is the Gross Debt Service (GDS) Ratio. The GDS ratio shows how much of your before-tax income is needed to cover the property’s expenses.
Note it’s the before-tax income your lender looks at for mortgage qualification purposes, even though you pay mortgage payments in after-tax dollars. Be sure to keep that in mind.
The GDS Ratio takes a property’s mortgage payments, property taxes, an amount for heat (usually based on the square footage) and maintenance fees (if applicable, for condos and townhouses) and divides the sum of that by your before-tax income.
You don’t have to worry about doing these calculations yourself. Lenders take care of them for you when calculating whether you qualify for a mortgage. It helps to understand them, though.
Prime lenders are looking for a GDS Ratio of 39% or lower. If your credit score is below 700, sometimes lenders will cap the GDS Ratio for you at 35% or lower.
Total Debt Service Ratio
The second debt ratio that lenders care about is the Total Debt Service (TDS) Ratio. The TDS Ratio is a lot like the GDS Ratio, except with one key difference. The TDS Ratio looks at how much of your before tax income is needed to cover the expenses of the property, plus any additional monthly debt payments that you might have.
The TDS Ratio takes a property’s mortgage payments, property taxes, an amount for heat, maintenance fees and monthly debt payments, and divides the sum of that by your before tax income.
For instalment debt (debt with regular fixed payments), your regular debt payment is used in the TDS ratio. For any revolving debt (credit cards and lines of credit), 3% of the outstanding balance is used in the TDS ratio.
Prime lenders are looking for a TDS Ratio of 44% or lower. If your credit score is below 700, sometimes lenders will cap the TDS Ratio for you at 39% or lower.
The Mortgage Stress Test
You may be wondering where the mortgage stress test comes into play. As mentioned, your mortgage payments are factored into both the GDS and TDS Ratios. However, it’s not the actual mortgage payments you’re going to pay. It’s the higher “fictional” stress tested mortgage payments.
As an example, even if you sign up for a 5-year fixed rate at 1.99%, you’re required to qualify as if you’re paying mortgage payments based on the qualification rate of 5.25%. This essentially reduces your borrowing power by 20% or so, but it also protects you in case rates were to increase in the future.
The Bottom Line
There you have it, the mortgage debt ratios. Are you ready to be pre-approved for a mortgage? Contact our mortgage experts today. We’d be happy to give you a helping hand.