What are “mortgage ratios” and why do they matter?

A question I commonly get asked is “what are those mortgage ratios people talk about?”

If you’re doing home buying research, chances are you’ve heard the terms gross debt service ratio, total debt service ratio, and loan to value ratio. Or as these mortgage ratios are more conveniently known, GDS, TDS, and LTV.

Here’s what you need to know:

1.  Gross Debt Service Ratio (GDS)

Your gross family income, or total income before deductions, is used for both the GDS and the TDS calculations. To calculate the GDS, we first total up your yearly shelter costs – mortgage payments, property taxes, and heat, and if applicable, 50% of your condo fees as well. Once we have this amount, we divide it into your annual income before deductions. The result is expressed as a percentage. Most lenders will want you to keep the percentage at 30-32%, max.

Here’s a simplified example. Let’s say you and your partner’s incomes total $100,000 per year, and you are thinking of buying a $500,000 condo. You have $100,000 in savings, so you need a $400,000 mortgage to make up the difference.

Here’s how the numbers play out:

Mortgage payments:  $21,197.52 (12 X $1766.46)
Taxes:  $5,000 (estimated)
Heat: $960 (estimated, 12 X $80)
Condo fees:  $2,400 (12 X $200, which is 50% of the estimated $400/month condo fee)
——————————————————
Annual shelter costs (total):  $29,557.52

Dividing this by your $100,000 income gives you a GDS of 29.56%.  It’s less than 32% – great!

What if your GDS ratio is too high?

You may be wondering what happens if it’s more than 32%.  The answer is “it depends”.  If you have no other debts, a great credit rating, and show that you regularly add to your savings, the mortgage lender may be willing to allow you a greater GDS than 32%, on an exception basis.

2. Total Debt Service Ratio (TDS)

To calculate the TDS, we add the above shelter costs to all your remaining debt commitments, such as a car loan / lease, amounts payable on lines of credit or credit cards, and other debt payments.  Continuing the above example, let’s assume you also have a car loan with a monthly $400 payment, and a student loan of $300 per month.

Let’s look at those calculations again:

Annual shelter costs from above: $29,557.52
Car loan payments per year: $4800 (12 X $400)
Student loan payments per year: $3600 (12 X $300)
————————————————————–
Total annual debt payments:  $37,957.52

Dividing this total by $100,000 gives you a TDS of 37.96%.  Since it’s less than 40%, you fit most lenders’ criteria – congratulations!

What if your TDS ratio is too high?

Consider what would happen if your car loan payment was actually $600 per month, and in addition to the student loan, you also owed $10,000 on various credit cards.  The picture becomes quite different:

Annual shelter costs:  $29,557.52
Car loan payments per year:  $7,200 (12 X $600)
Student loan payments per year:  $3,600
Credit card payments per year:  $3,600
—————————————————————
Total annual debt payments:  $43,957.52

Dividing this total by your $100,000 in income gives you the new TDS of 43.96%.    So what now?  Well, you have a couple of options.  You could significantly reduce the amount you borrow on the mortgage – in this case, you would need to reduce the mortgage amount by about $80,000 in order to bring your TDS under 40%.  Or, you could wait, reduce your expenses in other areas and aggressively pay down your non-shelter debts.  The key is to consult with a professional to understand your options and figure out what is the best way to proceed.

The key – and I can’t emphasize this enough – if you’re thinking of buying a home in the next year or two, do everything you can to avoid taking on any new debt.  As you can see from our example, it can really impact you in your home purchasing journey.

3.  Loan to Value Ratio (LTV)

The loan to value ratio, or “LTV”, is the simply the value of your mortgage (the “loan”) compared to the market value of the property, again expressed as a percentage.  In the example we used above, the loan to value is 80%, which is the $400,000 mortgage amount divided into the $500,000 purchase price of the condo.

There are implications that pertain to the LTV ratio.  If your down payment is less than 20% of the home’s value, or in other words, if your LTV is greater than 80%, your mortgage is considered a High Ratio Mortgage.  If that is the case, you will likely need to use mortgage default insurance (check out the CMHC website for more details).

Should you have any questions, please don’t hesitate to get in touch with me!

To learn more, check out more articles on my blog and let me know what you think.  Cheers!

Photo credit: [c] Thanakorn Lappattaranan for vecteezy.com