When you apply for a mortgage, the lender needs to know that you can handle the debt. They use a little math to figure that out, by doing two quick calculations: one is called the Gross Debt Service Ratio (GDS ratio) and the other is called the Total Debt Service Ratio (TDS ratio). Both of these are a comparison between the money you make and the money you need to spend.
The Gross Debt Service ratio adds up your mortgage payment, property taxes, and heating expenses per month and divides that total by your monthly income.
So let’s say your monthly income before income tax is $6,000 and your mortgage payment is $1,500, property tax is $200, and heating is $100. Your GDS calculation would be $1,800 divided by $6,000. As a percentage, that’s 30%. Lenders normally want to see that your GDS ratio is no more than 32%.
For a condominium, you also need to add in 50% of your condo maintenance fees before you divide. So going back to the example we just looked at, if the home is a condo where the maintenance fees are $200 per month, you’d add $100 to the $1,800 figure for a new total of $1,900 that would get divided by $6,000. In this case the GDS ratio becomes 31.67%. This is starting to border on “not affordable” according to the GDS ratio.
The Total Debt Service ratio adds your other debt expenses into the calculation. So that would now factor in your credit card payments, vehicle financing payments, and any other payments you need to make on loans or lines of credit. Lenders look for the TDS ratio to be 40% or less.
Going back to our same example, if you have a vehicle loan of $300 per month but you don’t have a credit card or other loan expenses, then to get your TDS, you’d add the $300 to the $1,800 of your other expenses (remember, that’s $1,900, if it’s a condo) and then divide by $6,000.
You’d get 35% (or 36.67% for the condo) as the TDS ratio – which is below the maximum of 40%. So lenders would consider that affordable for you.
Remember, no matter what a lender’s math tells them, it’s always smart to keep your debt levels as low as you can.
You don’t necessarily want to take out the biggest mortgage you qualify for. After all, home ownership is one of your biggest expenses in life. And that means it can also be one of the biggest sources of stress in your life. Don’t stress yourself out more than you need to. Think about finding a home that meets your basic needs, so you can be more free and flexible with your money.
Video: Financial expert Preet Banerjee provides an explanation of debt service ratios.
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