Canada's Condominium Magazine
Getting debt under control is a bit like getting anything else under control: you have to admit that there’s a problem before you can solve it. And how does one know whether or not one has a debt problem? Don’t rely on carping family and friends to tell you that you spend too much. Don’t even take the irrefutable evidence of a string of bounced cheques or missed bill payments as the painful proof that you are not in control of your fiduciary universe. Instead, get an impartial, cold-as-an-accountant’s-heart reading of your financial situation. In short, calculate your debt to income ratio, or DTI as the experts call it. This will tell you in stark, unadorned numbers how much you spend each month on debt payments. If you have never calculated this before, you could be in for a shock.
If you are intending to purchase a home at any time in the future (or borrow money for some other purpose), the importance of this step will become even clearer, for you cannot get a mortgage unless your DTI measures up. And you certainly don’t want to get your hopes up about buying that gorgeous condo by the lake only to learn that you don’t qualify for a mortgage. How disappointing would that be?
Having calculated your DTI, you now know for certain (assuming you were totally honest) where you stand. Where you should stand, to be considered a good, card-carrying debtor, is below 36 per cent, i.e., it takes less than 36 per cent of your gross monthly income to pay your monthly debts. Some financial advisors would put it even lower than that. But if your DTI comes in at more than 50 per cent, you need, as they say, professional help. A person with that rate of DTI will not normally qualify for a mortgage, though there are always exceptions. A DTI higher than 40 per cent could get you rejected by a lending institution, for that is the benchmark used by the banks in Canada.
In fact, there are two different calculations used by banks for determining a potential borrower’s credit-worthiness: the Gross Debt Service (GDS) and the Total Debt Service (TDS). Together, these two numbers give a lender a pretty accurate picture of your ability to take on more debt.
The GDS represents the percentage of the borrower’s income that goes (or would go) to pay housing costs: mortgage, property taxes, insurance, heating, and 50 per cent of condo fees. The benchmark used by banks in Canada for GDS is 32 per cent. This means in effect that your monthly housing costs should not exceed 32 per cent of your gross (pre-tax) monthly income. Canada Mortgage and Housing Corporation (CMHC) refers to this as Affordability Rule 1.
The TDS adds to the housing costs any other monthly debt obligations the borrower has, including credit card payments, car payments, and alimony payments. The benchmark for TDS is 40 per cent. This means that your entire debt load should not exceed 40 per cent of gross monthly income.
If you are not happy with your DTI at present, you have two broad options: lower your debt or raise your income. Doing both would be best of all, but if earning more is not in the cards just now, you can see that cutting the debt is your big challenge.
CMHC’s handy Mortgage Affordability Calculator will give you a good idea of how much mortgage you can afford with your present income and debts.