GDS and TDS: The Two Numbers You Need To Know Before Buying a Home in Canada

As an aspiring homebuyer, there are more than a dozen factors that you will have to consider before signing the dotted line. The factor which is going to consume the most amount of your time is probably affordability. Now homebuyer affordability is simply how much they can put down as a down payment and how much they can pay as monthly mortgage payments without having to sacrifice their living standards.

However, from the perspective of a lender, affordability is a more complex issue, which is assessed using two key metrics: Gross Debt Service Ratio (GDS) and Total Debt Service Ratio (TDS). These formulas are used by lenders to determine the maximum amount of money they are willing to lend to a borrower. Thankfully, as a homebuyer, you can calculate these ratios for yourself before applying for a mortgage to avoid any unpleasant surprises in the numbers.

• How to calculate the GDS and TDS ratios
• Explore the different ways in which they can impact your mortgage approval
• Steps to take if your ratios exceed the accepted limits

Gross Debt Ratio (GDS)

Your GDS ratio is a measure of the portion of your income that goes towards paying for your monthly housing costs, which includes principal, interest, taxes, and heat (PITH), as well as 50 % of your condo fees, if applicable. Most lenders follow a standard guideline of a 39 % GDS ratio, so it’s important to have a ratio lower than that to qualify for a mortgage.

To calculate your GDS ratio, add up all of your monthly housing costs, then divide that amount by your gross monthly income. Multiply the resulting number by 100 to obtain your GDS ratio.

Total Debt Ratio (TDS)

Your TDS ratio represents the portion of your income required to cover all of your debts, including car payments, credit cards, alimony, and any loans. To calculate your TDS ratio, add up all of your monthly debts and divide that amount by your gross monthly income. The formula for calculating TDS is the same as that for GDS, except it takes into account all of your monthly debts. The industry standard for a TDS ratio is 44 %.

To calculate your TDS ratio, simply divide the total amount of your monthly debts by your gross monthly income, and then multiply the result by 100. This will give you your TDS ratio, which is a crucial factor that lenders consider when assessing your creditworthiness.

For instance, Mr. & Mrs Smith, who is looking to buy a house, have a monthly income of $3,416 each, which amounts to a total of $6,832 per month and $81,984 per year. They estimate that their monthly mortgage payment and property taxes will be $2,250, their heating bill will be $75, they will make credit card payments of $250 per month, and they have $375 in monthly car loan payments.

In this scenario, their Gross Debt Service (GDS) ratio would be calculated as 

$2,325/$6,832 = 0.34 x 100 = 34%.

Similarly, their Total Debt Service (TDS) ratio would be calculated as 

$2,950 / $6,832 = 0.43 x 100 = 43%.

What Counts As Annual Income?

When calculating your debt service coverage ratio, several income sources can be used to determine your ability to cover your debts. These include

• Employment income, Variable income with a minimum two-year history (such as self-employed income, investment income, overtime, bonus, commission income, and part-time income with non-guaranteed hours)
• Pension income
• Rental income

However, below income sources cannot be used,

• Employment Insurance (EI) 
• Social assistance payments

By considering these income sources, lenders can better assess your ability to service your debts and make informed decisions about your creditworthiness.

How Does the Debt Service Ratio Impact Me?

Similar to your credit score, employment history, and down payment, your GDS and TDS ratios play a crucial role in determining your mortgage affordability. These ratios provide a clear indication to the lender of your ability to manage your payments in light of potential unforeseen expenses. 

Your mortgage broker will analyze your GDS and TDS ratios to determine whether they fall within an acceptable threshold, and will work with you to ensure that your mortgage application is as strong as possible. By understanding and managing your GDS and TDS ratios, you can improve your chances of securing a mortgage that fits your needs and budget

What Happens if I’m Over the Debt Service Ratio Limits?

If your ratios exceed the industry standard, it’s important to keep in mind that these ratio percentages are only general guidelines for the industry and may differ from lender to lender, both within the same type of lender and across different types of lenders (such as banks vs. non-depository lenders, B lenders, and private lenders). As a result, they are not set in stone, and some lenders may prioritize other factors when evaluating an applicant’s eligibility. 

For example, B lenders are more concerned with a loan-to-value ratio (LTV), as they lend based on equity, and income can be stated to adjust TDS/GDS ratios. The LTV is a straightforward calculation that compares the size of the loan to the property’s value.

There are situations in which a loan may be considered high-ratio (i.e., the down payment is less than 20%), which necessitates insurance from the Canadian Mortgage and Housing Corporation (CMHC) or private insurers such as Genworth or Canada Guaranty. For insured loans, the GDS or TDS can be as high as 39 to 44% if the borrower has a credit score of at least 680.

How Can I Improve It?

To improve your debt ratios and increase your chances of being approved for a mortgage, two key areas to focus on are your consumer debt and income. By increasing your income or reducing your debt, you can improve your ratios. This may involve finding ways to earn more money or paying off existing debts to decrease your overall debt load. These steps will demonstrate your financial stability and improve your chances of being approved for the mortgage amount you desire.

01Increasing Your Income

A good rule of thumb to keep in mind is that as your annual income increases, your debt ratio typically decreases since your debts become a smaller percentage of your overall income. While it’s true that increasing your income can automatically improve your debt ratio, it can be challenging in today’s market. However, it’s certainly not impossible. One effective way to generate more income is by taking on a side hustle, such as tutoring. As long as this additional income is reported to the Canada Revenue Agency (CRA) for at least two years, it can be factored into your debt ratio calculations.

You can also consider purchasing an owner-occupied rental property. This option allows you to include up to 50% of the rental income from a second unit as part of your income for qualification purposes. While it may require considering a different type of property, it’s a viable solution when direct improvement of your GDS/TDS is not feasible.

02Reducing your debt

A more common approach to improving your total debt service ratio is by reducing your debt. This option is generally more feasible and offers more benefits than attempting to increase your income. Consumer debt is often a source of stress for many individuals, but it can be easier to manage depending on your circumstances. If you possess assets or savings, paying down your debt will not only enhance your debt ratios but also decrease the amount of interest you owe.

The GDS and TDS ratios are essential factors to consider when assessing your overall creditworthiness. These ratios enable lenders to determine if your income can support your mortgage payments and if you pose a lower risk to the lender. However, if your GDS and TDS ratios exceed the industry standards, it would be advisable to address your debt obligations before approaching an alternative lender. Such lenders often have higher interest rates and fees associated with the loans. It is crucial to remember that lenders evaluate you based on your potential risk and ability to repay the loan, not your attributes or whether you are deserving of owning a home.

If you are planning to purchase a home and need guidance on managing your debt ratios, The Canadian Home can provide valuable assistance. We can help you prepare a plan to achieve homeownership while building a sound financial foundation. Please feel free to contact us.