When you apply for a mortgage, auto loan, or credit card, the lender will add up your monthly payments then include the proposed new payment in the calculation. Your before- and after- debt-to-income ratios determine your eligibility for a loan and the amount you may qualify for. A lender will look at both your Gross Debt Services (GDS) and your Total Debt Services (TDS) ratios.
Your Gross Debt Service is the percentage of your income that is needed to pay all of your monthly housing costs, including utilities and condo fees. For example, if your monthly income is $10,000, and your monthly housing costs are $4,000, you have a GDS of 40%.
Your Total Debt Services ratio is the percentage of your income used for housing, plus your monthly commitment to debt payments on loans, credit cards, and vehicle payments. For example, if as above you have a monthly income of $10,000 and housing costs of $4,000, plus debt payments of $750, your TDS is 47.5%.
In short:
GDS = Principle + Interest + Taxes + Heat + 50% condo fees / gross income
TDS = (Principle + Interest + Taxes + Heat + + 50% condo fees + debt payments)/ gross income
Why are they both important? A mortgage lender will factor these ratios in approving your loan application.
What Are Financially Healthy Debt Services Ratios?
First, you may see articles that refer to the national debt-to-income ratio. Gradual increases in the Bank of Canada's interest rate were followed by news reports that the national debt-to-income ratio topped 177.5% by the end of 2018. This figure compares the total of all credit market debt to all Canadians' disposable household income.
These overall national figures only affect your ability to get a mortgage, credit card, or car loan in a general way. The debt-to-income ratio that you need to pay attention to applies to your monthly income and bills. As a general rule of thumb, lenders want to see a GDS of 32% or lower, and a TDS of 40% or lower.
What Can I Do if My Debt-to-Income Ratio Is too High?
If you have a high debt-to-income ratio, you probably feel restricted by monthly bills and don't need a debt service calculator to tell you that your finances need work.
You can lower your debt-to-income ratio by following sound financial practices. Pay high interest credit cards off as quickly as possible. Don't add new debt by charging more than you can pay in one month.
Consider refinancing any loan, including mortgages or HELOCs. Establish a budget and stick to it. Your debt-to-income ratio will improve and you'll have more freedom to make the financial choices for mortgage loans, car loans, and credit cards you want to make.
Will it Help Me to Reduce My Debt-to-Income Ratio Before I Apply for a Mortgage or Other Loan?
Yes. Calculate your debt-to-income ratio before you apply for a major loan, especially mortgage pre-approval. Pay down credit cards so your monthly credit payments are as low as possible.
If you can wait until you have paid off your auto loan, a fully paid-for car will also help your debt-to-income ratio.
The lower the amount of monthly debt payments you have when you apply for a mortgage, the higher mortgage you can afford. This potential is one factor that a mortgage affordability calculator takes into consideration when it tells you how much you could afford to borrow.
Once you know your debt-to-income ratio and have a plan for reducing it if you need to, you're in a good position to investigate mortgage or credit card rates.
