Understanding Debt Servicing Ratios in Mortgage Financing: A Guide for Realtors
Today, we're going back to basics with a refresher on one of the most crucial aspects of mortgage financing—debt servicing ratios. These ratios, specifically the Gross Debt Service (GDS) and Total Debt Service (TDS) ratios, are pivotal in determining how much of a buyer's income will be dedicated to handling debt, which directly impacts their mortgage qualification.
Why Debt Ratios Matter:
When applying for a mortgage, buyers must meet specific criteria related to their debt ratios. If these ratios exceed certain limits, the buyer may not qualify for the mortgage they desire. However, there are situations where these limits can be adjusted, which we will explore.
Understanding the Gross Debt Service (GDS) Ratio:
The GDS ratio is calculated by summing up a buyer's housing costs—monthly mortgage payments (calculated with the stress test rate), property taxes, heating costs, and half of any condo fees—and dividing this total by the buyer's gross monthly income. The maximum acceptable limit for the GDS ratio is typically 39%. This means that no more than 39% of a buyer's pre-tax income should go toward these specific housing costs.
Breaking Down the Total Debt Service (TDS) Ratio:
The TDS ratio takes a broader approach by including other debts such as credit card payments, car loans, student loans, and other lines of credit. To calculate the TDS, add all monthly debt payments to the housing costs, and then divide by the gross monthly income. The standard maximum limit for the TDS ratio is 44%, allowing 44% of a buyer’s pre-tax income to be used for covering all debt obligations.
Exceptions to Debt Ratio Limits:
A common query from both clients and Realtors is whether these debt ratio limits can be stretched. For insured mortgages (typically those with less than 20% down), the answer is usually a firm no, as mortgage insurance companies are strict with the 39/44% thresholds.
Conversely, for conventional mortgages—those with a 20% or more down payment—there is more flexibility. In some cases, I have seen ratios stretched to 50% for both GDS and TDS with large banks, depending on the overall risk profile of the client. Clients with substantial down payments, excellent credit, and significant reserves are more likely to receive exceptions.
The Importance of 'Subject to Financing' in Offers:
As Realtors, it’s crucial to understand that when we request a 'subject to financing' clause, it often relates to securing these ratio exceptions. Even after all documents and property details are verified, the final approval for stretching ratios typically requires review by the lender's head office. This process can take anywhere from 1 to 3 business days. Including a financing subject in offers is essential to allow time for this review process, ensuring we can secure the best possible terms for our clients.
Understanding and effectively navigating GDS and TDS ratios can significantly impact your clients' buying capabilities. As Realtors, staying informed about these financial metrics and the nuances of mortgage financing will empower you to guide your clients through the complexities of buying a home, ensuring they make decisions that are financially sustainable.
If you have any questions please feel free to reach out.