Episode # 28 of the Mortgage Foundations Podcast
When it comes to applying for a mortgage, there are two important numbers that your Mortgage Broker will pay attention to when qualifying you for the mortgage. These are your Gross Debt Service, or GDS, and Total Debt Service, or TDS, ratios. They are commonly referred to as the debt service ratios or qualifying ratios, and depending on the type of mortgage product you require, they may be the most important aspect of your application and possibly the deciding factor in whether you are approved for the mortgage or not.
The purpose of the GDS and TDS is to determine whether the future mortgage payment can be afforded by the potential borrower. It is important to note that for mortgages, when calculating the GDS and TDS, your Mortgage Broker will use a rate that is different from your actual contract rate, in order to keep within regulations. This is called applying the 'Stress Test' and we use the benchmark rate of 5.25% or your contract rate plus 2%, whichever is higher. As an example, let's say the current contract rate is 4.99%. Your Mortgage Broker will need to use 6.99% in order to calculate your GDS and TDS to qualify you for the mortgage.
The 'Stress Test' is put in place to ensure that borrowers can not only afford their mortgage payment currently, but can also afford the payment if rates were to rise in the future.
In the instance of an Insured mortgage, one with less than 20% down payment, and an Insurable mortgage, one with more than 20% down, but still within the guidelines of an Insured mortgage; the maximum GDS and TDS are 39% and 44% respectively. There are no exceptions allowed and a clients GDS and TDS cannot go over the maximums, even by the slightest point of a percent.
Some Uninsured mortgage lenders do have programs available that feature extended qualifying ratios where the lender will mitigate the higher GDS and TDS numbers by looking at the strength of the application overall and potentially approve the client even with a higher GDS and TDS.
The Gross Debt Service, or GDS ratio is calculated by dividing the total housing costs by the total household gross income, or income before taxes. Basically, it calculates the percentage of a client's income that is required to pay all monthly housing costs. The amounts used for housing costs are the qualifying mortgage payment, including principal and interest, as well as property tax and heat expense. For condominium properties, half of the condominium fees are also included. When applying for a 2nd or 3rd mortgage, the other mortgage payments would also be included in this calculation as well.
For example, if your household income is $150,000 annually, or $12,500 monthly; the total housing costs must be less than 39%, meaning $58,500 per year, or $4,875 per month. If the housing expenses were to amount to more than $4,875 per month, the mortgage may not be approved.
The calculation for the Total Debt Service, or TDS ratio is similar; however along with housing expenses used to calculate the GDS, it includes all other liabilities as well. This will include any other liability that would result in a balance owing if not paid; such as credit card payments, line of credit and loan payments, car payments, child support, and others. Housing expenses for any other properties would also be included in the TDS calculation.
Using the example from before, if your household income is $150,000 annually, or $12,500 monthly; the total housing costs and other liabilities must be less than 44%, or $66,000 per year, or $5,500 per month. If they were to calculate higher, the mortgage may not be approved.
When applying for a mortgage, it is important that your Mortgage Broker properly calculates your GDS and TDS ratios ahead of time and knows different lenders guidelines regarding maximum ratios. This will ensure that you are aware of the maximum mortgage that you would qualify for.
While it is true that there are many things considered when you apply for a mortgage, such as credit score and credit history; the GDS and TDS ratios are often the most important factor and may present a hard stop on an application. Going over the maximum ratios may lead to a mortgage application being declined even when everything else on the file is good.
In conclusion, the GDS and TDS ratios are calculations that your Mortgage Broker and lender will use when gauging whether to approve you for a mortgage or not. The GDS takes total housing costs and divides the total by total household gross income; while the TDS calculation adds on all other liabilities. The industry standard is 39% for GDS and 44% for TDS and while some lenders do allow for extended qualifying ratios on their Uninsurable mortgage products, an Insured or Insurable mortgage has no exception to the rule.