The debt servicing ratio is the most important ratio in mortgage lending. It’s tells us the ratio of debt payments-to-income. If too much of income is going towards debt payments, then this is a problem. It will become too difficult to make payments.
In Canada, there are two key ratios: Gross Debt Servicing Ratio (GDSR) and Total Debt Servicing Ratio (TDSR). For the most part, we must keep these ratios below 39% and 44% respectively. There are certain types of lending programs that are purely equity based that don’t consider these ratios. They are never first choice because they are more expensive.
The value of using a mortgage broker is that how the ratios are calculated can vary from lender-to-lender based on their underwriting policies. Knowing which policies are most favourable in certain instances can mean the difference between an approval or a decline.
Gross Debt Servicing Ratio (GDSR)
The GDSR is:
[Monthly Mortgage Principal and Interest Payment + (Annual Property Taxes/12) + Monthly Heat + 50% of monthly condo fee, if applicable] / (Annual Gross Employment Income/12)
The monthly P&I payment is an amortized payment. Depending on the lender, program, insurability, it is usually amortized over 25-30 years for the calculation.
The monthly heat estimate is usually between $85-120/month depending on the size of the home. Given all the publicity about increasing hydro rates in Ontario, I suspect lenders will start upping the amounts they use in this calculation.
Total Debt Servicing Ratio (TDSR)
The TDSR is the exact same as the GDSR except that we add on other monthly payments to the numerator (bolded below):
[Monthly Mortgage Principal and Interest Payment + (Annual Property Taxes/12) + Monthly Heat + 50% of monthly condo fee, if applicable + Other monthly debt payments] / (Annual Gross Employment Income/12)
Other Monthly debt payments usually show up on the credit bureau report. If there exists a fixed payment amount such as an amortizing car loan then we use the monthly equivalent amount. If the amount is “revolving” such as an unpaid balance on a credit card then we usually have to use 3% of the outstanding balance. For example, $10K of debt x 3% = $300 payment.
Let’s meet house shopper Bill. Bill’s realtor has suggested he talk to a mortgage broker first to get pre-approved. This way, Bill and his realtor known what they can know the range of houses that he can look at.
From his application, we learn that Bill has the following:
- $100,000 salaried job base income (or $8333/month)
- Bill has $400/month in other debt payments
- $3600 estimated property tax (or $300/month)
- $100/month heat
- Assuming a mortgage balance of $500,000, the actual mortgage payment might only be $2,000 per month. However, using the new qualification rules and Bank of Canada qualifying rate, the P&I payment for the ratio is $2806/month.
- Not shopping for a condo
GDSR: [Monthly Mortgage Principal and Interest Payment + (Annual Property Taxes/12) + Monthly Heat + 50% of monthly condo fee, if applicable] / (Annual Gross Employment Income/12)
[2806 + 300 + 100 + 0] / 8333 = 38.5%
TDSR: [Monthly Mortgage Principal and Interest Payment + (Annual Property Taxes/12) + Monthly Heat + 50% of monthly condo fee, if applicable + Other monthly debt payments] / (Annual Gross Employment Income/12)
[2806 + 300 + 100 + 0 + 400] / 8333 =43.3%
Bill is excited because his ratios are less than 39% and 44%. Go Bill Go!!
This example is an over simplification because there are many things in an application that can be a factor. For example, he may have other properties, other debts, alimony payments, bonus income, credit limits, etc. How these are calculated and are treated can be different from lender to lender so it’s important to work with a mortgage professional that is independent and has choice.
About the Author:
Ian Mucignat, CFA, is an independent mortgage agent at TMG The Mortgage Group. He graduated from Wilfrid Laurier University with a Bachelor of Business Administration, minoring in Economics and is a CFA Charterholder. Ian has worked in the mortgage industry since 2000 at lenders, banks, and brokerages. If you are purchasing, renewing, or refinancing your mortgage don’t hesitate to contact Ian directly for a free consultation.