
How do Lenders Approve You for a Loan?
All lenders, banks and credit union base their lending on two major ratios:
GDS: Gross Debt Service Ration
TDS: Total Debt Service Ratio
These two lending ratios automatically rate your ability to take on more credit given your current financial circumstances. It takes into account your income, current debt, taxes, heat/hydro, and living expenses.
Both ratios are automatically calculated on every credit application to determine your credit capacity. Of course, credit scores, personal assets and job tenure are also used to service credit deals.
Your banker is going to want your GDS score to come in at around 32% and your TDS to not exceed 40%.
Christine’s Tip:
Let’s use your TDS Ratio – really this one is the most important.
Think of your TDS ratio like a BMI score for a healthy lifestyle and do not go over 40%, no matter how much you want to.
First, determine your monthly mortgage payment or rent, property taxes, and debt or loan payments.
You will also need to take your annual gross income and determine the monthly amount.
Here is the formula (I know, some of you are saying, “I hate math,” but this is literally how your bank qualifies you) so let’s do it together.
MR + CL + TAX + $100 / MI = TDS x 100(%)
MR=monthly mortgage or rent payment
CL=monthly credit card or loan payments (add all together)
TAX=monthly property taxes or $0 if you are renting
MI=gross monthly income
Here is an example: A married couple wants to move to a larger home, but they are not sure if they can qualify. The value of their home has gone up considerably since they purchased it, but so have all the other homes in their area, which limits what they can spend on their next purchase.
Partner 1 earns $52,000,
Partner 2 earns $26,000
Total = $78,000 divided by 12 = $6,500/month.
Current mortgage payment = $1,970/month and property taxes = $285/month. Current debt payments including lines of credit = $971/month. Here’s what it would look like.
($1,970 + $971 + $285 + $100) divided by $6,500 x 100(%) = 51.17%
Clearly, this couple would not qualify with the banks as presented because their monthly debt load is too high, ($971/month) and it is putting them over the 40% threshold.
There are only three ways to get the ratio in line. 1) add more income, 2) lower debt, or 3) consolidate into a new mortgage and spread out the payment to lower the monthly expenses.
To find out if this couple could indeed sell and move to another residence, we would have to determine if they had enough equity in their home to consolidate their debt, cover expenses and still have a deposit from the sale to purchase another home. Here’s a quick example of a larger monthly mortgage payment with higher property taxes but with no debt, assuming this was paid off with the proceeds of their home sale and keeping the same income. New mortgage payment = $2,126/month and new property taxes = $310/month.
($2,126 + $0 Debt + $310 + $100) divided by $6,500 x 100(%) = 39.02% Viola! Now they qualify!
Try this out on your own budget. Having monthly loan payments, hinders your ability to improve your situation. If you calculate your TDS and are over the 40%, you probably already feel it financially every month. Why not look at consolidating, downsizing, or finding new ways to eliminate your debt. Talk to your banker. Remember, high interest is the common man’s “silent killer” to their future.