TL;DR: debt service ratio is the percentage of your income before tax that is used to maintain your debt obligations and housing expenses. These ratios are significant to how much mortgage you qualify for. As a guideline, your housing (and taxes, heat, etc) should cost no more than 35% of total income, and your total debt (housing + car loan, student loans, credit cards, etc.) should take up no more than 42% of your total, before-tax income.
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“Debt servicing” is the measure of your ability to meet all of your financial obligations. There are two ratios that are used to determine whether you can debt service (i.e. "afford") a mortgage. The first one is called the “gross debt service” ratio (GDS) and the second is called the “total debt service” ratio (TDS).
Gross debt service ratio (GDS)
When a lender is looking at your gross debt service ratio, they add together all of your expenses in relation to the property you are purchasing – including your proposed annual mortgage payments, heating, property taxes, and a percentage of your condo fees (if applicable). When you combine all of these monthly payments and divide it by your total monthly income, this forms your GDS. Generally speaking, your GDS should not exceed 35%. For those who have exceptional credit, the allowed GDS ratio can increase to as high as 39%.
Total debt service ratio (TDS)
Your lender will also examine your total debt service ratio. This time, they will take your property expenses and add it to all of your other financial obligations (such as your credit cards, loan payments, outstanding lines of credit, support payments, etc.). After all the obligations are added up, they are again divided by your monthly income. Generally, this ratio should not exceed 40% but the maximum allowable TDS ratio can be as high as 44% (or higher for certain situations and clients).
Bob and Sue are currently looking at purchasing a particular property that they want to make their new home. After running some numbers, their proposed housing expenses will include a $1500 monthly mortgage payment, $200 in property taxes ($2400/year), and no condo fees. Their total household income is $90,000 annually, which comes to $7500/month. $1700 divided by $7500 equals 0.227, or 22.7%. In this case, they come well under the required 35% GDS.
Now we will figure out their TDS. Let’s say Bob and Sue have a monthly car payment of $300. Bob also has child and spousal support payments, totaling $500 each month. Their credit cards and lines of credit amounts to a financial obligation of $700 each month. These payments add up to $1500 each month, and after we add in the $1700 of housing expenses, we arrive at a total of $3200/month for all of their financial obligations. $3200 divided by $7500 equals 0.427, or 42.7%.
All of this information from Bob and Sue is very helpful for the lender, and if you understand it, it can be helpful for you too. Based on their GDS alone, Bob and Sue can easily afford the house they are considering. But factor in their other expenses and the picture is not as clear – the lender will likely look at their credit score next to determine if they can afford the property, or if they should set their sights a little lower due to being a credit risk.
Put another way, if Bob and Sue were able to drastically decrease their balances on their credit cards and line of credit, they would likely qualify for a more expensive home if they so desired.