Only traditional mortgage lenders use the Total Debt Service (TDS) ratio to determine whether a loan application should be accepted. The ratio measures the potential borrower’s ability to manage their debt, and lenders use it to decide on creditworthiness.
If you’re about to fill out an application alone, it pays to know some practical strategies to enhance this TDS ratio. You can increase your borrowing power with simple techniques, like reducing debt and managing your finances better.
Working with your TDS ratio can help you get accepted for loans and improve your financial literacy.
Understanding TDS Ratio
The Total Debt Service Ratio (TDS) is one formula lenders use to gauge borrowers’ reliability in managing and repaying debt. It involves calculating all the monthly debts by an applicant’s gross monthly income. The percentage that results highlights how financially healthy an applicant is. The TDS covers housing costs like mortgages and utilities plus debts like personal loans and credit cards. Even car payments are added. It covers the total debt load.
TDS Ratio= Total Monthly Debt Payments x 100
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Gross Monthly Income?
Many lenders in Canada prefer that this TDS ratio be under 40%. That means no more of a borrower’s gross income should be used to pay off debt. This percentage helps lenders forecast whether a borrower has enough financial wiggle room to manage changes in income, emergency expenses, and the like.
Borrowers must understand that mortgage payments and fixed debts are straightforward when calculating the TDS ratio. However, variable costs like property taxes and utilities can increase or decrease over time, affecting the ratio and the fixed expenses.
Why TDS Ratio Matters for Mortgage Approval
The TDS matters because it shows a lender how much available income an applicant has compared to debt. It’s essential for several reasons.
- This ratio can affect the interest rates that a borrower gets on a mortgage. When the ratio is low, it signals to lenders that you’re a low-risk applicant.
- The TDS also acts as a red flag for borrowers taking on more debt than they can handle. It’s a proactive way to head off defaults and other financial issues.
- The numbers from this ratio also highlight applicants who can manage debt well.
- Understanding this ratio can also help applicants get a clear picture of their overall debt load.
- The TDS ratio also clearly indicates to lenders whether an applicant can handle the possibility of rising interest rates associated with variable-rate mortgages.
TDS vs GDS
Another ratio lenders consider is the Gross Debt Service (GDS) formula. The Canadian Mortgage and Housing Corporation (CMHC) supplies a brief overview of these ratios. The GDS ratio is your housing costs divided by your pre-tax income. Most lenders want to keep this ratio below 3 9% of your income to qualify.
GDS Ratio= Mortgage Payments + Property Taxes + Heating + Condo Fees (if any)
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Gross Monthly Income
The TDS ratio is different and includes payments on other debts.
GDS Targets Housing Expenses.
The GDS is targeted to specific housing-related costs. It indicates whether a potential borrower can pay the mortgage and other related expenses. The target for the GDS is lower than the TDS. Lenders want to be sure that all of the costs associated with the mortgage won’t overwhelm an applicant.
The TDS Handles A Bigger Scope
Lenders look at an applicant’s ability to handle the entire swath of debt obligations with the TDS. They tend to focus on this ratio when they are trying to decide how an applicant would be able to handle a spike in interest rates or another change in their finances, like a sudden job loss.
Steps to Reduce Debt and Improve Your TDS Ratio
The calculations for either of these ratios are fairly simple, but a few factors can affect the numbers. Remembering that these numbers are guidelines and not necessarily strict rules is essential. However, a few simple steps can help you reduce your different debts and improve your TDS ratio, specifically.
- Paying down your debt is a simple way to decrease this ratio. Remember, the TDS can signal to a lender that an applicant is overextended with some debts. Credit card debts top the list of the ones that you should tackle. If you make only minimum payments on your cards, the balance stays high, and that can impact your TDS ratio.
- Making a larger down payment is another way to decrease this number. A dedicated savings account can help you put away a little extra money to accomplish this goal.
There are some other expenses to work with.
Tips to Managing Expenses to Lower Your TDS
A private loan is a way to manage expenses and lower this ratio. By consolidating your debt into one loan, you can free up your cash flow to tackle high-interest-rate debts. Private lenders have a quicker, more flexible application process. Their criteria are less strict than those of traditional banks and credit unions. For example, a private lender will accept contract income and money made through sole proprietorships.
You can also manage your expenses by reducing discretionary spending. Cutting out expenses like entertainment, shopping, and dining out can help you divert some more money and pay your debts faster.
Jonathan and Ron Alphonso are real estate experts whose opinions and quotes are routinely sought out by major publications like Global News in the Toronto Star. You can learn more about the private loans and alternative mortgages offered at Mortgage Broker Store. They maintain websites at mortgagebrokerstore.com and powerofsalesontario.ca.
