When you apply for a mortgage, your lender needs to answer one question: can you afford the payments? To find out, it looks at how much of your income already goes to your bills, and how much would be left once you add a mortgage payment on top.
Lenders measure this with two percentages, called debt service ratios. One is known as GDS and the other as TDS. Together, they decide whether you qualify for a mortgage and how much you can borrow.
Here is what each one includes, the limits you need to stay under, and what you can do if your numbers come out too high.
Key takeaways
- Debt service ratios express how much of your income already goes toward your debts, as a percentage.
- GDS covers only the cost of running your home, and CMHC caps it at 39%.
- TDS takes that same figure and adds every other debt you carry, with a ceiling of 44%.
- The mortgage payment used in the calculation is not the one you will actually make: lenders base it on the qualifying rate, which is your rate plus 2% or 5.25%, whichever is higher.
- Ratios that come out too high can usually be brought back down before you apply, by paying off debt, finding a lower rate or increasing your down payment.
What is a debt service ratio?
A debt service ratio is one of the first calculations a lender makes when it opens your file, and what it does is quite simple: it compares what you owe to what you earn. The result, expressed as a percentage, gives the lender a quick read on whether you can keep up with your current debts and take on a mortgage as well.
There are two of them, and your application needs to pass both. The gross debt service ratio (GDS), looks only at what it costs to own and run your home. The total debt service ratio (TDS), starts from that same figure and adds every other debt you are paying off.
Debt service ratio or debt-to-income ratio?
If you have done any reading online, you have almost certainly come across the term debt-to-income ratio, or DTI. It’s the American equivalent of what Canadian lenders use, and while the underlying idea is the same, the two are not interchangeable.
DTI compares your monthly debt payments to your monthly income and treats housing like any other expense. Canadian lenders work differently: they split the calculation in two, run it against your gross yearly income, and apply the qualifying rate rather than your real payment.
What are the GDS and TDS limits?
In Quebec, as in the rest of Canada, these limits come from the Canada Mortgage and Housing Corporation, better known as CMHC. Your GDS cannot exceed 39% and your TDS cannot exceed 44%, and these are the two numbers your lender holds your file up against.
Insured and uninsured mortgages: are the limits the same?
Not entirely, and what decides it is the size of your down payment, with the line drawn at 20%.
- An insured mortgage: your down payment is under 20%. An insurer such as CMHC guarantees the lender it will be repaid even if you stop making payments, and the insurance premium is added to your loan.
- An uninsured mortgage: your down payment is 20% or more, so no insurance is required.
What changes from one to the other is how much flexibility you have. On an insured mortgage, the CMHC limits are firm: at 39% and 44%, your file either qualifies or it does not.
On an uninsured mortgage, each lender sets its own benchmarks. Most stay fairly close to CMHC’s numbers, but a strong application backed by steady income and a good credit score can earn a little extra room. From there, it comes down to the lender and how cautious it chooses to be.
How to calculate your GDS and TDS
Now that you know the limits, the useful question is where you actually stand. Lenders handle these ratio calculations when they review your file, but there is nothing stopping you from doing the exercise at home to get a sense of your situation before applying for a mortgage.
One detail matters a great deal here. The mortgage payment that goes into the formula is not the payment you will actually make, because lenders base it on a qualifying rate: your own rate plus 2%, or 5.25%, whichever is higher. This is the mortgage stress test, applied right inside the calculation.
1. Gross debt service (GDS)
Your GDS ratio compares your monthly housing costs to your gross yearly income, meaning your income before taxes, and it needs to come in at 39% or less.
Four expenses go into the debt service GDS ratio:
- Your mortgage payment, both principal and interest;
- Your property taxes, meaning your municipal and school taxes;
- Your heating costs;
- Half of your condo fees, if you have any.
GDS = (mortgage payment + property taxes + heating) ÷ gross yearly income × 100
Take a couple earning $95,000 a year before taxes who borrow $350,000 over 25 years at a rate of 4.25%. Because of the qualifying rate of 6.25%, their lender works with a payment of $2,292 a month rather than the $1,889 they will really be paying.
- Mortgage payment: $27,500 a year
- Property taxes: $3,600
- Heating: $1,200 (a common estimate when the real amount is unknown)
Their housing costs therefore add up to $32,300 for the year. Divided by $95,000 and multiplied by 100, their GDS ratio comes out at 34%, comfortably under the 39% limit.
2. Total debt service (TDS)
Your TDS ratio begins with those same four housing expenses, then adds everything else you owe, and it needs to stay at 44% or less. Alongside your housing costs, your debt service TDS ratios take in:
- Your credit cards;
- Your lines of credit secured or not;
- Your car loans, or a long-term vehicle lease;
- Your personal loans and student loans;
- Support payments, if you make any.
TDS = (mortgage payment + taxes + heating + other debts) ÷ gross yearly income × 100
Credit cards and lines of credit deserve a word of caution, because lenders count them using their own method. The amount that ends up in your file may therefore have little to do with what you actually pay each month.
Let’s go back to the same couple, who are also paying off a car and carrying a balance on a credit card.
- Housing costs: $32,300 a year
- Car payment: $5,100
- Credit card: $1,440 ($120 a month, as counted by the lender)
That brings their total to $38,840. Divided by $95,000 and multiplied by 100, their TDS ratio comes out at 40.9%, once again under the 44% limit.
Your numbers are too high: what can you do?
If your calculations put you past one of the limits, the situation is rarely as final as it looks. Several adjustments can bring your ratios back into range before you submit your application.
Pay off your debts
This is the quickest route, and credit cards and lines of credit are the place to begin, since they tend to weigh heavily on your TDS ratio even when the balances are modest.
Keep one thing in mind, though: a line of credit you have paid off but left open can still count against you. If you no longer need it, closing it or reducing its limit will help your file.
Look for a better rate
Since your payment is calculated at your rate plus 2%, every fraction of a percentage point you save lightens both ratios at the same time. A mortgage broker compares offers from several lenders on your behalf in a single step, which is the simplest way to find the best interest rates available to you.
Choose a longer amortization period
Spreading your loan over more years lowers your monthly payment, which brings both ratios down with it. The trade-off is that you will pay more interest over the life of the mortgage.
Increase your down payment
The more you put down, the less you need to borrow, so your payment shrinks and your GDS ratio follows. A larger down payment of 20% or more, removes the need for mortgage insurance, which takes you out of the territory where the limits cannot be negotiated.
Count your rental income
If the property you want to buy has a unit you can rent out, part of that rent can count as income. CMHC allows up to 50% of it, and up to 100% for the second unit of a duplex you live in yourself. A higher income naturally pulls both ratios down.
Add a co-borrower
Buying with someone else means their income is added to yours, which lowers both ratios. The only thing to watch is that their own debts do not cancel out the gain.
Reconsider your budget
If nothing else is enough, looking at less expensive properties remains the most direct solution. And even at the same price, a home that is better insulated, taxed at a lower rate or free of condo fees will already lighten your GDS ratio.
One last piece of advice will not change your ratios, but it will spare you a good deal of stress: get a mortgage pre-approval before you start visiting properties. Discovering a problem when you are about to make an offer rarely leaves enough time to solve it.
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