What Is a Debt-To-Income Ratio and How Does It Affect Your Mortgage Approval?
Debt-to-Income Ratio: The Basics
A debt-to-income ratio (DTI), such as GDSR (Gross Debt Servicing Ration) and TDSR (Total Debt Servicing Ratio), is a measure of your financial responsibility and an indicator of your ability to make your monthly mortgage payments. Lenders use DTI ratios to determine the risk you pose to them as a borrower, based on your total debt load, income, and history of debt repayment. Your debt-to-income ratio is an important element of any mortgage application and may be a deciding factor in your approval.
How to Calculate Your Debt-to-Income Ratio
Your DTI ratio can be calculated using one of two formulas: the gross debt service ratio (GDS) or the total debt service ratio (TDS).
Your gross debt service ratio represents how much of your gross income is required to make your housing-related payments. To calculate this ratio, first add up all of your monthly housing expenses (mortgage payments, heating costs, municipal taxes, and 50% of any condo or maintenance fees), then divide by your gross monthly income.
Typically, you want to aim for a GDS no larger than 39% to get approved with a bank or AAA lender, but alternative lenders, and even some banks, are more flexible than others. Private lenders are the most flexible when it comes to this since they lend mainly on the asset.
Your total debt service ratio also looks at your gross income in relation to your required housing payments. Unlike the GDS ratio, however, the TDS ratio also considers your other debts. To calculate your TDS ratio, simply add up all of your monthly housing expenses as well as your other monthly debt repayments and divide by your gross monthly income.
Typically, you want to aim for a TDS no larger than 44% when hoping to get approved by a bank, but as with the GDSR ratio, many lenders have exceptions and this may be subject to change depending on your lender.
The Significance of Your DTI Ratio
Lenders use debt-to-income ratios as a measure of risk. Having a high DTI ratio indicates to lenders that you are already taking on a significant amount of debt and spending substantial portions of your income on debt repayment. A borrower with a high DTI ratio may be perceived as fiscally irresponsible and living beyond their means.
A low debt-to-income ratio indicates to lenders that you are a financially responsible borrower. Also, it demonstrates that you have a significant cushion of safety regarding your debt repayments.
How Your Debt-to-Income Ratio Can Affect Your Mortgage Approval Chances
When determining your mortgage eligibility, lenders will often consider both your GDS ratio and your TDS ratio. By examining these debt-to-income ratios, your lender will determine if you fall within their personal risk threshold. A borrower with a high DTI ratio may be perceived as unable to manage their debt repayments. Having a high debt-to-income ratio does not always discredit your application, but it can serve as a red flag for many lenders.
Luckily, DTI ratios are not used as a sole measure of your eligibility. When looking at your debt percentages, lenders will consider a number of different factors. Beyond your salary, the regularity of your pay, your field of work, and your bonus and overtime structure may also be factored into your borrower profile. Furthermore, your credit score and history will also be taken into account.
If you want to be approved for a mortgage loan, you must keep your DTI within your lender’s threshold. While some lenders are more flexible than others, some AAA lenders will be able to make exceptions on GDS ratios going as high as 42% and TDS ratios as high as 46%, with some B lenders going as high as 70/70 on certain mortgage products. It is important to note that while a GDS ratio of 42% may be acceptable, it is certainly not favourable and this might be reflected in a slightly higher rate. In order to qualify for good mortgage rates, you should aim to keep your GDS and TDS ratios well below the lender’s threshold.
For more information on how to increase your odds of mortgage loan approval, check out our guide on mortgage approval in 2022.
Improving Your Debt-to-Income Ratio
If you want to increase your mortgage approval chances, you might want to start by improving your debt-to-income ratio. Here are a few ways in which you can improve your DTI ratios and become a more attractive borrower:
Reducing Your Existing Debt
One of the best ways to improve your odds of mortgage approval is to pay off your existing debts before submitting your application. Paying off debts can be difficult, but through consistent budgeting and careful planning, you may be able to avoid any compounding interest payments.
Based on your financial situation, you may want to consider postponing your home purchase for a few years in order to first catch up on your existing debts. Paying off your debts before taking on a mortgage will not only increase your odds of approval but also put you in a more sustainable financial position.
If you are looking to begin paying off your debts, you may want to start by creating a list of all your current debt obligations and payments. To maximize your long-term savings, you can sort your debts by interest rate and prioritize repayment on the highest-interest debts. Another way to reduce your monthly interest payments is by consolidating all your current debts under one low-interest loan. For more information on debt consolidation, check out our guide on how to consolidate your debts using a home equity loan.
Using Rental Income to Improve Your DTI Ratios
Under some conditions, the Canadian Mortgage and Housing Corporation (CMHC) will allow you to consider rental income as part of your gross monthly income when calculating your DTI ratios. Typically, you can include up to 50% of the income generated by a residential rental property when calculating your DTI ratios. You can also deduct the home taxes and utility costs of the rental property when calculating your monthly housing expenses. In some cases, certain lenders allow for more of the rental income to be counted towards your ratios.
Suppose you are currently living within a residential property and renting out a second unit attached to the home. In that case, you may be able to include 100% of your rental income in your gross income calculations.
For more information, check out our guide on counting market rents towards your income on your mortgage application.
Break the Cycle of Debt
For many borrowers, reducing debt is easier said than done. Sometimes, you may need outside help to break the cycle of debt and allow you to improve your financial standing. Here at Clover Mortgage, we are committed to helping you land the best mortgage for you.
Are you already a homeowner?
Our expert team can help you consolidate your debt through a home equity loan.
Are you looking to improve your odds of approval?
We work with over 50 different lenders, many of whom offer far more flexibility than the banks.
Contact Clover Mortgage today to schedule a free consultation! Call 416-764-6222 or email us at info@clovermortgage.ca.
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