Debt Service Ratios and Why They Matter

mortgage-debt-ratio-formulaIf you’re purchasing a home for the first time, chances are you’ll need a mortgage. Before you start house hunting, it’s a good idea to get pre-approved for a mortgage. Being pre-approved answers the all-important question, how much house can I afford? Lenders don’t just pluck this figure out of thin air; they use debt service ratios to determine if you can handle your mortgage. The two ratios lenders rely on are the Gross Debt Service (GDS) and Total Debt Service (TDS) ratios.

Gross Debt Service (GDS) Ratio
The Gross Debt Service (GDS) ratio examines the per cent of your pre-tax monthly pay needed to cover your monthly housing costs. Housing costs include mortgage payments, property taxes, heating bill and 50 per cent of condo fees (if applicable). As a homebuyer, you should strive for a GDS below 32 per cent.

Calculating the GDS
As a homebuyer, it’s a good idea to get the handle on how lenders calculate the GDS. The GDS is calculated by totaling your monthly housing costs (Mortgage Principal and Interest, Property Taxes, and Heating and dividing it by your pre-tax monthly pay. Multiply that figure by 100 to get the GDS.

GDS = (PITH + ½ Condo Fees)/Pre-Tax Monthly Pay x 100

Let’s run through an example to get a better handle of it. If you have a monthly mortgage payment of $1,340, property taxes of $250, monthly heating bill of $100 and monthly pre-tax pay of $5,800, your GDS would be:

GDS = ($1,340 + $250 + $100) / $5,800 x 100 = 29.14%

In this case the GDS falls below 32 per cent, so you shouldn’t have any problem affording your monthly housing costs.

Total Debt Service (TDS)
Now you that understand the GDS let’s take a look at the GDS’s bigger brother, the Total Debt Service (TDS) ratio. The TDS is similar to the GDS, but it includes your other debts beside your mortgage, including car loans, credit card outstanding balances, and student debt. The ratio examines the per cent of your pre-tax monthly pay needed to cover your monthly housing costs and your debt. As mentioned above, your monthly housing costs include mortgage payments, property taxes, heating bill and 50 per cent of condo fees (if applicable), plus your monthly debt service costs. As a homebuyer, you should strive for a TDS below 40 per cent.

Calculating the TDS
The TDS is calculated by totaling your monthly housing costs (Mortgage Principal and Interest, Property Taxes, and Heating), plus your monthly debt service costs, and dividing it by your pre-tax monthly pay. Multiply that figure by 100 to get the TDS.

TDS = (PITH + ½ Condo Fees + Other Debt)/Pre-Tax Monthly Pay x 100

If you have a monthly mortgage payment of $1,340, property taxes of $250, monthly heating bill of $100, monthly car loan of $300 and monthly pre-tax pay of $5,800, your TDS would be:

TDS = ($1,340 + $250 + $100 + $300) / $5,800 x 100 = 34.31%

The TDS falls below 40 per cent, so you shouldn’t have any problem affording your monthly housing costs.