Debt Service Ratios: How Much House Can I Afford?

by True Wealth Advisors

With Financial Literacy Month (FLM) effectively over, it doesn’t mean Financial Literacy ends. It’s imperative to continue to build on the steps discussed in previous articles. Once you have a budget and your financial house is in order, it’s time to start thinking long-term about real estate. Real estate is a great tool that when structured properly can exponentially increase your net-worth over time.

Debt service ratios answer the all-important question: how much house can you afford? Lenders use these ratios to determine how much money they’ll let you borrow for a mortgage. When you’re house hunting, lenders use two debt service ratios: the Gross Debt Service (GDS) and Total Debt Service (TDS) ratios.

Gross Debt Service (GDS)

The GDS is the percent of your monthly income needed to cover your household expenses, including your mortgage payments, property taxes, heating bill and half of your condo fees (if applicable). Aim for a GDS below 32 per cent.

GDS Formula

To calculate the GDS, add your monthly household expenses (Mortgage Principal, Mortgage Interest, Property Taxes, and Heat) and divide the sum by your monthly take-home pay. Multiply that number by 100 to get the GDS.

GDS = (PITH + ½ Condo Fees)/Gross Monthly Income x 100

For example, if you have a mortgage payment of $1,300, property taxes of $200, heating bill of $75 and take-home pay of $5,600, your GDS would be:

GDS = ($1,300 + $200 + $75) / $5,600 x 100 = 28.13%

In this example, you have a GDS of 28.13 per cent, which is below the industry standard of 32 per cent.

 

Total Debt Service (TDS)

The TDS is similar to the GDS. The TDS includes your household expense, but also other debts, including credit card debt, car loans and student loans. The TDS looks at the percent of your monthly income needed to pay your household expenses and debt. Your household expenses include your mortgage payments, property taxes, heating bill, half of your condo fees (if applicable) and debt payments . Aim for a TDS below 40 per cent.

TDS Formula

To calculate the TDS, add your monthly household expenses (Mortgage Principal, Mortgage Interest, Property Taxes, Heat and other debt) and divide by the sum by your monthly take-home pay. Multiply that number by 100 to get the TDS.

TDS = (PITH + ½ Condo Fees + Other Debt)/Gross Monthly Income x 100

For example, if you have a mortgage payment of $1,300, property taxes of $200, heating bill of $75, car payment of $200 and take-home pay of $5,600, your TDS would be:

TDS = ($1,300 + $200 + $75 +$200) / $5,600 x 100 = 31.70%

You have a TDS of 31.70 per cent, which is well below 40 percent, so you should be fine.

If any of this still seems confusing to you, don’t panic, we’re here to help. Whether you’re looking to own your first home or you’re considering owning an investment property, let’s help you crunch the numbers, make sure it makes sense. Owning your home or an investment property can be very rewarding when done properly.

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