Gross debt service ratio. Loan-to-value ratios. Total debt service ratio. What the heck does all of this mean? School may be out, but it’s time to get to know your ratios and how they can affect your mortgage.
It’s mortgage terminology 101 day! Let’s start with the basics. There are an assortment of “ratios” that relate to your financial ability to pay your mortgage that lenders will look at when you apply for and/or change your mortgage so it’s important you know and understand how they work. We know how confusing these ratios can be, so we’ve created this handy little guide to help you understand how they all work.
The three ratios that matter when funding a mortgage
Gross debt service (GDS) ratio: this is the percentage of your gross income, before taxes that you have to cover your monthly home expenses; utilities, mortgage payments, taxes and/or condo fees if you own a condo. The ratio is calculated by adding these expenses together and dividing that number by your gross monthly income. The magic number for most lenders is a GDP of 39% of your gross monthly income is used to service these expenses.
Total debt service (TDS) ratio: this is the percentage of your income, after taxes that you have to cover ALL of your monthly expenses like a car payment(s), credit cards, loans, and any other bills you have PLUS your housing costs. The magic number for most lenders is a TDP of 44% of your income is used to service these expenses.
A simple way to calculate your magic numbers would be to add up your monthly housing expenses and all of your monthly debts and multiply by 12 to get the total amount for the year, and then divide that number by your annual salary. Multiply that figure by 100 to get your GDS/TDS ratio.
Here's an example:
Monica would like to buy a house and her annual salary is 82,000, which makes her gross monthly income $6,833. She estimates that her mortgage payment and property taxes will be $2,050, heat will be $75, and she also pays $250 in credit card payments a month along with a $300 car loan.
GDS: $2,125 / $6,833 = .31 x 100 = 31%
TDS: $2,675 / $6,833 = .39 x 100 = 39%
Loan-to-Value (LTV) ratio: this a calculation that helps a lender measure your mortgage risk. The higher your LTV is the riskier a lender will think you are. The LTV ratio is calculated by dividing the total mortgage loan amount into the total purchase price of the home (appraised property value). For example, a $500,000 home with a mortgage of $400,000 will give you an LTV ratio of 80%. Most mortgage lenders will provide better loan terms to borrowers who have loan-to-value ratios no higher than 80%.
Ratios are only industry guidelines
Still with us? Keep in mind that the ratios we have discussed are simply industry guidelines and each lender will review your mortgage application based on the ratios, your credit rating, history of repayments (if you have an existing mortgage) and other factors so don’t get too worried if your ratio’s don’t fit the industry norm.
We are here to help!
Lenders will look at many other factors to assess your application even if your ratios are high. We can work with you to lower your ratios by tackling your credit card debt and other debt with loan consolidations and other avenues. That could help to turn a higher-rate mortgage approval into a more manageable mortgage payment. We can help you run the numbers, figure out your ratios and provide many options to help you get the financing you deserve.