Are you in the planning phase of a home purchase? The best place to begin is knowing how much the house fits into your income. All mortgage lenders, even private mortgage lenders, consider a TDS/GDS ratio when reviewing your application.
Subtract your actual expenses, which among others would include electricity bills, taxes, and fuel costs from your income. The remaining amount is where at a personal level you can begin evaluating how much house you can budget for.
Well, your monthly house rent should not be included as an expense here, because that money will go to paying off the mortgage. To get the actual figure an aspiring homebuyer can afford, mortgage experts have a way of coming around that by looking at a person’s TDS and GDS ratios, credit score, house appraisal value, and other aspects. Let’s explain these ratios.
Total Debt Service Ratio (TDS)
TDS is a debt formula used to measure the proportion of gross income already spent on payments, as well as those relating to housing. Lenders see each and every property in the hands of a borrower as a responsibility (talking of credit card balances, property taxes etc.) So they compile all those and compare the total amount against the borrower’s ratio of income to decide whether to extend the credit.
So the formulae would be:
| TDS | = | Property Taxes + Annual Mortgage Payment + Other Debt Payments |
| Gross Family Income |
In Canada, this ratio should stay between 32% and 40%. The total debt service ratio allows lenders to get a clear picture of how well a borrower can repay the borrowed amount as well as manage their existing monthly expense.
Gross Debt Service (GDS)
GDS simply refers to the percentage of gross annual income that the borrower “must” earn to be able to cover all their payments associated with housing. The amount should be able to cover expenses such as property taxes, mortgage principal, interest, condominium fees, heating and so on. In Canada, lenders keep this ratio at 32%.
The GDS Formula would be:
| GDS | = | Taxes + Principal + Other Debt Payments |
| Gross Annual Income |
How Banks look at you when deciding whether or not to approve your home loan application
When planning to buy a house it’s good to know what your lender will be looking to approve your loan request so you can fix whatever needs to be fixed. As such, the first thing the lender check is your credit score (FICO score in other words.) This is calculated based on one’s credit history and discipline in repaying loans. The number ranges between 350 and 850, and the higher it is, 600 plus the easier a bank can approve the borrower for credit.
Another key focus is on the TDS and GDS ratios, both of them need to stay below 40%. Next in the list is House Appraisal, where the lender uses an unbiased estimate to measure the home’s value, to determine whether the property is worth the mortgage amount requested.
Practically, knowing everything about how much you can afford when buying a home helps you to plan and keeps you from being house-rich and cash-poor after you’ve taken your mortgage.
