When you apply for a mortgage, lenders look at two key metrics–gross debt service (GDS) ratio and total debt service (TDS) ratio–to determine how much money they’ll lend you. So, having high existing debt can impact your eligibility for a loan and lower the amount of money you can borrow.
A lot of people have student loans, but this isn’t necessarily cause for alarm because student loans typically carry low interest rates and payments are generally lower than a credit card or a line of credit of the same size. Depending on the profession, lenders might also look at that debt a bit differently. For instance, I had a client who was a resident doctor. Medical school debt can run high, but doctors also have high earning potential. Each year her salary was scheduled to increase so lenders took her future salary into account rather than just looking at her student loan balance.
Let’s a look at a hypothetical home-buying couple and see how loans might impact their GDS and TDS.
Calculating Gross Debt Service (GDS) Ratio
Lucy and Tim are traditionally employed and have a monthly gross (before taxes) income of $9,000. They want to buy a $450,000 condo outside of Vancouver. Assuming they put down 20 per cent ($90,000), they’d need to borrow the remaining balance of $360,000. We’ll assume that they qualify for a fixed mortgage rate of 3 per cent, amortized over 25 years, and make monthly payments, so their monthly payment would be $1,703.68. But we still need to factor in other housing costs, so we’ll add in $300/month for strata fees, $160.80/month for property taxes and $75/month for heating to calculate their total monthly housing costs.
$1,703.68 + $300 + $160.80 + $75 = $2,239.48
To calculate Lucy and Tim’s GDS, divide their monthly housing costs of $2,239.48 by the total monthly gross income of $9,000. Then multiply the result by 100 to get a per centage.
$2,239.48/9,000 x 100 = 24.8 per cent
Ideally, lenders want to see a GDS below 39 per cent for those with good credit and an owner-occupied property. With a GDS under 32 per cent, Lucy and Tim have a gross debt service ratio that most lenders would consider reasonable. But what about student loans and other debt? That’s why the total debt service (TDS) ratio matters too.
Calculating Total Debt Service (TDS) Ratio
TDS refers to the portion of your gross monthly income that goes towards debt such as housing costs, car loans, student loans credit card balances or lines of credit. To be a desirable candidate for a mortgage, your TDS shouldn’t exceed 44 per cent if you have good credit (or 42 per cent if your credit isn’t so great).
We already know that Lucy and Tim have a total monthly gross income of $9,000 and total monthly housing costs of $2,239.48. If they have a monthly car payment of $150 and student loan payments totalling $400 per month, then their monthly debt load (not including mortgage debt) is $550.
Total Household Debt – $550 + 2,239.48= $2,789.48
To calculate Lucy and Tim’s TDS ratio, divide the total debt of $2,789.48 by $9,000 in monthly income. Then multiple the result by 100.
$2,789.48/9,000 x 100 = 31 per cent
With a TDS radio of 31 per cent, Lucy and Tim are below the 44 per cent limit, so even with some modest loans, they’d be likely to qualify for the loan they need as long as they had good credit and a good employment history.
What This Means for You
Whatever your financial situation, the key is to understand your income and monthly expenses, whether that includes loans, child support or other obligations. Working backwards is a good way to see what you can realistically afford. This CMHC calculator can help you compare your debt and housing expense payments to your income. (But note that these calculators usually don’t account for mortgage insurance premiums if you’re taking out a high-ratio mortgage.) I use this monthly expense checklist to help clients examine their finances.