One of a lender’s many criteria when assessing your mortgage eligibility is your debt service ratio. These debt-to-service ratios measure your ability to repay a mortgage by ensuring that your total debts do not exceed a certain percentage of your gross (before-tax) income. These ratios are then used to determine how much money a lender will lend you for a mortgage. 

Key Takeaways

• Gross debt service (GDS) and total debt service (TDS) are two ratios that lenders use to assess your eligibility for a mortgage.
• The mortgage stress test will artificially inflate your GDS and TDS to ensure you can manage future rate increases.
• You can improve your chances of qualifying for a mortgage by reducing your GDS/TDS.

Debt Service Ratios for Mortgages Explained

Lenders use debt service ratios to determine your ability to repay your mortgage. They do this primarily using two factors expressed as ratios: gross debt service (GDS) and total debt service (TDS) ratios. GDS is the maximum shelter costs you can afford each month, while TDS is the maximum total debt repayments you can afford each month. In simple terms, GDS and TDS are calculated by dividing your monthly debts by your gross (before-tax) income. Lenders may reconsider your ability to manage mortgage payments if the percentage of debt compared to your income needs to be lowered.

What is the Gross Debt Service Ratio?

Gross debt service (GDS) ratio is one of two essential calculations lenders use to determine how much money they will lend you for a mortgage. The GDS ratio comprises the expected monthly housing costs for your new home, including scheduled stress-tested mortgage payments, heat, property taxes, and, where applicable, 50% of condo fees. This number is then divided by your total monthly household pre-tax (gross) income. Typically your GDS must be at most 32% for uninsured mortgages and 39% for insured mortgages. 

What is the Total Debt Service Ratio?

The total debt service (TDS) ratio is the second key calculation lenders use to determine how much money they will lend you for a mortgage. The TDS ratio comprises the expected monthly costs for your new home plus your total monthly debt payments, which include: revolving monthly credit card payments, lines of credit payments, personal loan payments, car loans or leases, child/spousal support, and student loans. This number is then divided by your total monthly household pre-tax (gross) income. Typically your TDS must be at most 40% for uninsured mortgages and 44% for insured mortgages. 

Calculating Your Debt Service Ratios

Calculating your debt service ratios is vital in assessing your borrowing capacity. These ratios measure how much of your income is used to service your debts and can help indicate whether you can repay them. Additionally, monitoring these ratios over time can help you understand how well you manage and pay off debts.

Gross Debt Service Ratio (GDS) Example Calculations & Formula

GDS is calculated as follows: 

GDS = (Mortgage Payment + Property Taxes + Heat + [Condo fees/2]) / Monthly Income

For example: Consider yourself a household with a combined gross annual income of $120,000. You are looking to buy a $500,000 condo with a 20% down payment ($100,000) at a rate of 4.49%. The monthly mortgage payment would be $2212, annual property taxes on the home are 1% (which equates to $416.67 a month), heat costs are expected to be $100 a month, and condo fees are $400. This household’s gross monthly income is $10,000 ($120,000/12).

GDS = ($2212 + $416.67 + 100 + [$400/2]) / $10,000 

GDS = $2928.67 / $10,000

GDS = 0.2928 or 29.3%

Total Debt Service Ratio (TDS) Example Calculations & Formula

TDS is calculated as follows: 

TDS = (All debts in GDS calculation + all other debts) / Monthly Income

For example: Consider in addition to the above-projected household expenses, you have a monthly car loan payment of $200 and student loan payments of $400. 

TDS = ($2928.67 + 200 + 400) / $10,000

TDS = $3528.67 / $10,000

TDS = 0.3528 or 35.3%

What Affects Your GDS and TDS Scores?

Lenders use GDS and TDS ratios as well as your credit score to assess risk and better understand if you will have the ability to make payments on your mortgage. In general, the lower your debt servicing ratios, the easier it will be to obtain a mortgage. Risk to lenders is reduced because they can see that you’re managing your debt well and have the capacity to take on more. However, let’s discuss some other contributing factors that you should be aware of that could impact these scores. 

Mortgage Stress Test

The mortgage stress test was introduced in 2018 by the federal government and was created to assess whether you will be able to pay your mortgage should interest rates rise. The stress-tested qualifying rates determine the mortgage amount you can borrow – limiting your borrowing capacity and impacting your qualifying amount. The mortgage stress test affects anyone who is a new buyer, as well as homeowners looking to switch lenders or refinance their mortgage. The mortgage stress test is based on either the rate offered by your lender plus 2% or 5.25%, whichever is higher. 

To illustrate this using the scenario from the GDS and TDS calculations above, the interest rate offered at 4.49% plus 2% equates to 6.49%. Since this number is higher than 5.25%, the household would be stress tested at the higher rate of 6.49%. Using the stress-tested amount, you would be looking at a monthly payment of $2677 a month (realizing this isn’t the actual payment, just the stress-tested qualifying payment). This monthly payment at the stress-tested rate must still fit within acceptable GDS and TDS ratios to qualify for the mortgage. The new TDS and GDS ratios are 33.9% and 39.9% after using the stress-tested monthly amount. With this calculation, you can see how the stress test affects what you can afford by automatically reducing your borrowing capacity.

Mortgage Loan Insurance

Mortgage loan insurance (also called mortgage default insurance) is an insurance that protects lenders while allowing buyers to purchase property when they have less than 20% to put as a downpayment on a home purchase. When this insurance covers your mortgage, your lender will be able to recover the money lent to you in the event you are unable (default) to make your payments, alleviating some of the risks to the lender. 

In Canada, there are 3 mortgage loan insurance providers. They are Canadian Mortgage and Housing Corporation (CMHC) – a crown corporation, along with privately owned Sagen (previously Genworth), and Canada Guaranty. Mortgage loan insurance (also called mortgage default insurance) ranges from 2.8% to 4% of the mortgaged amount. This cost can either be paid in cash or added to your mortgage balance (upon qualification), as the total mortgage you can carry still needs to fall within your qualifying mortgage ratios. 

How to Improve Your GDS & TDS Ratios to Qualify for a Mortgage

There are a few ways to improve your GDS/TDS ratios if you want to qualify for a mortgage. If you have the savings, you could make a larger down payment which will decrease monthly mortgage payments, or you could re-assess your budget and opt for a lower-cost home which would also reduce your overall monthly mortgage costs. Additionally, increasing household income by considering a new job with a higher salary or waiting until your salary is higher before applying for a mortgage can reduce your debt service ratio. Another option to consider is to add a co-signer to the mortgage to boost your borrowing capacity. Finally, prioritizing and paying off any other current debts (for example, credit card debts or car payments) you are carrying will automatically improve your TDS ratio.

Frequently Asked Questions

What is a good gross debt service ratio?

A good gross debt service ratio in Canada is at most 32% for uninsured mortgages and 39% for insured mortgages. 

What is a good total debt service ratio?

A good total debt service ratio in Canada is at most 40% for uninsured mortgages and 44% for insured mortgages. 

What is an uninsured mortgage?

An uninsured mortgage is one that was previously never insured. A mortgage cannot be insured if the home’s purchase price is over $1 million, for amortizations exceeding 25 years, or if the mortgage is refinanced.

Final Thoughts

Mortgage debt service ratios are essential when assessing your ability to take on more debt. It measures how much of your income is used for debt coverage of your mortgage payments and can help you make informed decisions about your borrowing. When considering any loan or mortgage, the lender needs to calculate your debt service ratios to understand your financial position. Speaking with a mortgage expert will help you better understand your borrowing capacity.