WHY ARE DEBT SERVICING RATIOS IMPORTANT WHEN APPLYING FOR A MORTGAGE?
HOW ARE DEBT SERVICING RATIOS CALCULATED?
There are two ratios you need to worry about—gross debt servicing (GDS) and total debt servicing (TDS)
Gross debt servicing (GDS)
This is the maximum amount you can afford for shelter costs each month. It’s your monthly housing costs divided by your monthly income.
Total debt servicing (TDS)
This is the maximum amount you can afford for debt payments each month. It’s your monthly debt and housing costs divided by your monthly income.
If too much of your income is already going to housing costs and debt payments, according to your lender, you may not be able to afford to take on more debt.
WHAT DOES DEBT SERVICE RATIO MEAN AND WHY IS IT IMPORTANT?
Lenders use ratios to assess risk and understand if you will be able to make your payments on a mortgage. Generally, lenders like to see a GDS ratio around 32% and a TDS ratio that is no greater than 40%. If the ratios are higher, that does not mean you won’t qualify for a mortgage, but you may end up paying a higher interest rate.
In general, the better your debt servicing ratios and credit score, the lower your interest rate will be. This is because lenders view you as more reliable and it shows that you manage your money well and make your payments on time. Even if you need to refinance now, at a slightly higher rate, you can look at getting into a lower rate in a couple of years, when you mortgage term is up for renewal.
Your debt servicing ratio also lets you know how well you’re managing your budget. If your TDS ratio is over 44%, you are spending too much of your income on debt already and you may be unable to borrow without a co-signer. A co-signer’s credit history and income is factored in with yours. This gives the lender some reassurance that the payments will be made because the co-signer is as responsible for the mortgage as you are.
CALCULATING YOUR PERSONAL DEBT SERVICING RATIOS
Start by adding up your monthly debt payments. Include those fixed costs that you must pay every month:
| Housing costs | Debt costs |
● Rent or mortgage payments● Property taxes● Heat● 50% of condo fees |
● Loan payments, such as car, student, or personal loans● Credit cards (3% of the outstanding balance)● Outstanding bill payments not on a credit card (dental, medical, repairs)● Interest charges for line of credit payments● Spousal or child support payments |
Next add up your monthly income:
- Pay cheque (before taxes)
- Retirement or pension payments
- Benefits payments
- Spousal or child support
- Rental income
- Any other monthly income
Formulas:
Gross debt servicing ratio |
Total debt servicing ratio |
Housing Cost———————— x 100 Total income |
Housing Costs + Debt Costs————————————- x 100 Total income |
Examples:
Your income (before taxes) is $6,500 per month. You have a monthly mortgage payment of $1,400, property taxes of $ $300, and $ $100 for heat. Your GDS ratio is calculated as $1,800/$6,500 x 100 = 27.69%
Your income (before taxes) is $6,500 per month. You spend $300 for your car payment. You have $2,500 in credit card debt, and 3% of the outstanding balance is $75 for a total of $375 per month. Your TDS ratio is calculated as $2,175÷ $6,500 x 100 = 33.46%.
To learn more about specific mortgage approval ratios, check out this handy article.
Note: If you have a two-income household, include the debt payments and income for both of you. This is important because you have more income between you, and you share the cost for some of the debt.
TIPS FOR LOWERING YOUR DEBT SERVICING RATIOS
There are two basic ways to improve your debt servicing ratios—increase your income or reduce your debt.
Increasing your income is not always possible, although it could include a raise at work, finding a new job with better pay, or taking a second job. If you do find yourself with a little extra cash—maybe you received a year-end bonus—consider using it to pay down your debt.
Paying down your debt and not adding to it is the best way to improve your debt servicing ratio. Here are a few ideas to get you started:
- Avoid making new purchases, especially if you need to use your credit card to make the purchase.
- Create a budget and see where you can cut expenses. Apply those savings to your debt.
- Call your credit card company and try renegotiating a lower interest rate. With a lower rate, more of your payment will be applied to what you owe
- If you have money sitting in an account that is not earning much interest, consider applying it toward your debt, which tends to have a higher interest rate.
- Explore options to refinance equity from your home to pay off debt (work with your mortgage broker to form a plan).
DEBT SERVICING RATIOS AND YOUR CREDIT SCORE
Your debt servicing ratios do not directly affect your credit score but carrying a large amount of debt can negatively affect both. And lenders will look at both when assessing your mortgage application. The good news is that reducing your debt improves your credit score as well as your debt servicing ratios. Work with your mortgage broker to create a plan on how you will reduce your debt and improve your ratios. This informative credit video may be useful, straight from a seasoned underwriter.
Your debt servicing ratios give lenders information about your ability to repay the money you borrowed while your credit score provides information about the way you manage credit. Do you make payments on time? Do you have a history of borrowing and repaying money?
Now that you know how a lender is going to assess your mortgage application, you can take the necessary steps to lower your debt servicing ratios and get that mortgage approved!
Mortgage Mark Herman, Top Calgary Alberta mortgage broker
Mortgage Tips for Canadian Buyers
Buying a home should be exciting – not exhausting.
Mortgage Checklist
1. Determine your Budget
Determine what your monthly budget is for the following:
– Mortgage payment
– Property taxes and Condo fees (if applicable)
– Utilities, maintenance and repair
2. Pre- Qualification
You will be asked to provide information about yourself and whoever is going to be on the mortgage with you. All of the information that is relayed is strictly confidential. You will be provided with a Mortgage Disclosure and Consent document to review and sign. Next, your Mortgage Broker will pull your credit bureau and review your overall situation and start the document collection process so they can determine your maximum purchase price and min down payment. A rate hold can be obtained once documents have been reviewed.
3. Document Preparation
Income for Salary or Hourly Employees
– Most recent Pay Stub
– Letter of employment – must be on company letterhead and state your name, position, length of employment. Guaranteed min # of hours and rate of pay or annual salary. It also must have contact information for the lender to call to verify employment once an offer has been made.
– Last 2 years Notice of Assessments (NOAs), T1 Generals and T4 slips for any hourly overtime, commission or bonus income
Income for Self-Employed:
– Last two years Notice of Assessments and T1 generals + confirmation no CRA tax in arrears
– Last 2 years statement of business activities for Sole Proprietors
– Articles of incorporation and Last 2 years company financials for Corporations/Partnerships
Down Payment/Closing Costs
– Anti Money Laundering Laws require the lender to review your 90 day Bank or Investment account histories to verif funds in account for down payment. Any frequent or large deposits and transfers must be verified. Online statements are acceptable, but smartphone screenshots are not.
– Gift letter + gift funds deposited to account, proof of Line of Credit available or sale of existing home proceeds (if applicable)
– You are required to have 1% to 1.5% of the purchase price on top of your down payment for costs relating to the closing of your new home purchase such as home inspection, property tax adjustments, appraisal fees, title insurance, moving expenses, utility hook ups and home fire insurance.
4. Find a realtor and start looking at houses
If you do not already have one, we can highly recommended you to one of our realtor connections. You can the proceed to look for a home that is within your pre-determine price. When you have found a house that you want to purchase, make sure your realtor makes it conditional on obtaining satisfactory financing. It is best to specify 7 to 10 days. It is also recommended to include the condition of a satisfactory house inspection.
5. Mortgage Approval
Once you have a confirmed Offer to Purchase on a house, notify your Mortgage Broker right away so they can start to work on getting the mortgage approved. At this time you will need to give your Mortgage Broker the following documents:
– Updated paystub, job letter and down payment account histories if they are more than 30 days old
– Completed & signed Offer to Purchase
– MLS listing (fact sheet) of the property, if private sale – old MLS listing or appraisal to confirm details
– Lawyer Information (Including the firm and solicitor’s name, address, phone and fax)
– Copy of void cheque for mortgage payments
6. Commitment Signing
A mortgage commitment is provided to your Mortgage Broker by the lender after your deal is approved. Your Mortgage Broker will spend time to review your mortgage commitment with you and let you know about any other lender requirements that need to be fulfilled. You then need to submit those requirements in order to get a final mortgage approval.
7. House Appraisal and Inspection
If required, your Mortgage Broker will order and schedule an appraisal. The mortgage lender determines th requirement of this. This is also the time where you should arrange to have an inspection performed on the home by a certified house inspector. The main purpose of a home inspection is to determine if the home has any existing major defects or any major repairs coming up in the near future. A home inspector will determine structural and mechanical soundness, identify any problem areas, provide cost estimates for any work required and provide you with a report.
8. Condition Removal
Once the lender has confirmed they have all the required documents and the deal is approved you can contact your realtor and have the financing condition removed. At the same time, if the home inspector’s report came back satisfactory, that condition can be removed as well. Do not remove conditions until all amendments to your real estate contract have been reviewed and accepted by the lender as it could affect your financing.
9. Meet with Lawyer
Once all of the conditions for the mortgage are verified and approved, the lender will package your mortgage up and send it to your lawyer whereupon your lawyer will call you in for a meeting one to two weeks before your possession date to go over the legal matters of the mortgage. You will review and sign documents relating to the mortgage, the property you are buying, the ownership of the property and the conditions of the purchase. Your lawyer will also ask you to bring a certified cheque or bank draft to cover closing costs and any other outstanding costs. Avoid signing up for duplicate Mortgage Life/Disability insurance at lawyers.
10. Possession Day
Once the transfer of money has occurred between your lawyer and the seller’s lawyer, you will officially own your new home. Your realtor will arrange to meet with you at your new home and do a walk through to make sure everything is as it should be and also to give you the keys. Congratulations!
Creating happy homeowners by providing personal bespoke mortgages solutions with uncompromising service.
Mortgage Mark Herman
Mortgage Broker & Overall Happiness Creator
Mortgages Are Marvellous
Mark@MortgagesAreMarvellous.ca
Serving Clients In: Calgary, Okotoks, Airdrie, Strathmore, Cochrane, Lethbridge, Red Deer,= & Medicine Hat.
Also Serving: All areas of Alberta including: Edmonton, Sherwood Park, Fort Saskatchewan, Leduc, Nisku, Stony Plain, Spruce Grove, Beaumont and St. Albert. Wood Buffalo / Fort McMurray, Grande Prairie, Airdrie, Lloydminster AB, Okotoks, Cochrane, Camrose, Chestermere, Sylvan Lake, Brooks, Strathmore, High River, Wetaskiwin, Lacombe, Canmore, Morinville, Whitecourt, Hinton, Olds, Blackfalds, Taber, Coaldale, Edson, Banff, Grand Centre, Innisfail, Ponoka, Drayton Valley, Cold Lake, Devon, Drumheller, Rocky Mountain House, Slave Lake, Wainwright, Stettler, St. Paul, Vegreville, Didsbury, Bonnyville, Westlock, Barrhead.