Outdated mortgage formulae mean trouble

GDSR calculations are out of date.



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Shopping for a home? No doubt you’ll head off to the bank where your mortgage lender will ask for some numbers they need to calculate how much you can borrow. They’ll be calculating both your GDSR (gross debt service ratio) and your TDSR (total debt service ratio). And they’ll pronounce the amount you’ll be able to safely borrow and repay. Maybe.

Maybe not.

First, let’s look at what these ratios are how they’re calculated. GDSR is the percentage of your gross income required to pay basic housing costs including your mortgage payments, property taxes, heating and condo or strata fees (if you have any). They add up these numbers and then divide by your monthly gross income.

So if your monthly mortgage payment is $1,350, your average monthly property taxes are $335 and your heating costs are $100 a month, your total would be $1,785. Now let’s say you make $67,000 which works out to $5,583 a month. The next step is to divide your total monthly payment by your gross monthly income and multiply by 100. So, 1785 ÷ 5583 x 100 = 31.97%.

Financial institutions want to see your GDSR under 32%, so you’d be just on the edge of their criteria. If they were trying to build up their mortgage business, you’d get the mortgage. If credit was in tight supply and they were watching their Ps and Qs, you might be declined. However, under their rules they won’t give you a mortgage if your GDSR is over 32% because if you’re spending more than 32% on “basic” housing costs that could make it difficult to cover your other expenses.

TDSR is the percentage of your gross income required to cover basic housing costs plus all your other debts, including your car loan, consolidation loans, lines of credit, student loans and credit card limits.

Keep in mind if you have 10 credit cards each with $2,000 limits, lenders will count that as $20,000 you have already borrowed, regardless of whether you’re carrying a balance or not since you can draw on those credit card limits at any time. Ditto your line of credit; regardless of how much you’ve used, the lender will count your limit against you for the purpose of the TDSR calculation. Lenders want your TDSR to be under 40%.

Here’s where the theory and reality of debt service ratio come to blows.

If you’re making $67,000 a year, you’re not taking home $5,583 a month. Nope, you’ve got to give the tax man his pound of flesh first. If you live in Alberta you’ll pay $14,775 in tax on that gross income. If you’re in Nova Scotia, you’ll pay $17,854. If you’re in Ontario you’ll pay $14,324 and if you’re in B.C. you’ll pay $13,681.

Let’s use Alberta as our example. So you make $67K and you pay $14,775 in income tax, which leaves you with $52,225, or $4,352 per month, in income.

Your basic housing costs of $1,785 divided by your net monthly income of $4,352 means you’re spending 41% of your net income on your home. And that’s before we take into account home insurance, maintenance and electricity, water and sewage and any other costs you may have to pay.

Assuming you spend $100 a month on insurance and set aside $300 for maintenance and everything else, your percentage jumps to 50%! And that’s how so many people have ended up spending half their income on their shelter costs.

My rule of thumb is to spend no more than 35% of your income on shelter. If you have no other debt at all…then there’s another 15% you could roll into shelter (but wouldn’t you rather spend that on life?)

Can you imagine if you have a car payment, if you’re shelling out big bucks for day care, if you suddenly find yourself living on one income? And what if you have a whole bunch of deductions off your pay cheque aside from tax: CPP, EI, union dues, medical benefit premiums and the like. Is it any wonder that people turn to credit cards and lines of credit to make ends meet?

The problem lies in the fact that these ratios are way out of date. Why is gross income even on the table? Even after years and years of saying, “You don’t make your gross income, you and the tax man make your gross income,” no one in the ivory towers has woken up to this reality.

If you want to know why Canadians are carrying too much debt, this is reason No. 1. Don’t even get me started on the willy-nilly handing out of lines of credit and credit cards. My blood pressure just can’t take it.

6 comments on “Outdated mortgage formulae mean trouble

  1. Great article. You're absolutely right! Why is anything based on gross income? I don't do my monthly budget based on my gross pay. I'd be an idiot to. I do it on what gets put in the bank.

    Net – Mortgage (taxes etc) – RRSP – loans – basic necessities = Play money
    Gross – Mortgage (taxes etc) – RRSP – loans – basic necessities = You're going to have a bad day ( and be OVER budget!!!)


  2. As a mortgage professional I can tell you that most lenders don't take the limit of credit cards into consideration in debt servicing. So as long as they are paid down to a balance that is serviced by a 3% repayment amount and your ratios work then you will qualify for a mortgage. The downfall is after you get your home you can go and rack up your cards…I've never liked this method…


  3. I am a mortgage agent and dealt with several lenders during last 6-7 years. No lendes takes into consideration the amount of credit limit for calculating TDS. Only the amount borrowed is taken into consideration and they calculate it at 3% of the outstanding amount.


  4. Hi Gail! My wife and I love the show and the column. I'm not a lending professional but my life experience agrees with the other posts below… nobody cares how high my credit limits are anymore. I remember years ago (circa 2003) that my total ability to go into debt was considered, but that check seems to have dissapeared (I've moved almost every year since then as a result of military postings). I believe the paradigm shift for the credit score seems to have moved to percentage borrowed vs credit limit.

    If you could dig up either the references for TDSR calculation, and/or the current algorithims used by Trans Union/Equifax for credit scoring, I think it would make a very interesting article!


  5. You're correct, it would be more accurate and transparent to use after-tax income. However, I suspect it would not affect lending practice … as long as tax amount is relatively constant among borrowers, this would simply cause the "net DSR" to have a higher rate.

    Looking at this from a macro scale, there's still the same total amount of funds to be loaned and the same number of borrowers looking for mortgages, these criteria are simply mechanisms lenders use to determine who is the best borrowing candidates and where to draw the line between acceptable and non-acceptable risk. As Canada has not experienced a foreclosure crisis, it does not appear that the current DSR criteria are failing. So, with a change to Net DSR making no substantive difference other than clarity, I don't see much incentive to change the system.

    Maybe the only advantage is helping borrowers understand this debt vs play money concept. But mortgage brokers and financial advisors can do this regardless of the measures lenders are using.


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