The Five C’s of Credit: Capacity

Thanks for stopping by our blog, if you haven’t had the chance, check out my last couple posts in this series where I discussed financial character and capital. Today I wanted to talk about the third C, capacity. When it comes to mortgages the term capacity is used to describe your ability to repay your mortgage.

Introducing Gross Debt Servicing and Total Debt Servicing Ratios

Your ability to repay the mortgage is determined by two ratios, the first is your Gross Debt Servicing (GDS) ratio and the second is your Total Debt Servicing (TDS) ratio. The two are very similar, and serve the same purpose, but they are calculated slightly differently. Whether a bank approves you for a mortgage will heavily depend on these ratios, with each bank having slightly different threshold criteria.

GDS:

(Annual Mortgage Payments+Property Taxes+12Condo Fees+Annual Heating)/Gross Income

TDS:

(Annual Mortgage Payments+Property Taxes+12Condo Fees+Annual Heating+All Repayment Obligations)/Gross Income

Don’t stress yourself out trying to calculate your ratio and understand those equations. Your banker will calculate it for you as you fill out the application together. As a general rule of thumb, you don’t want the percentage to be over forty percent, as a higher figure suggests that too much of your income will be consumed by your debt facilities.

New Homeowners

If you are purchasing a new property and aren’t sure of the property taxes, condo fees, or heating costs don’t worry, the bank will figure all of that out for you through an appraisal. A lot of consumers get upset with their bankers because they feel that these ratios are impersonal and don’t consider their character and perfect history of repayment. It’s important to remember that these ratios also help protect you by giving you an objective understanding of affordability and prevent you from making an impractical decision.

Taking on a mortgage that you have a hard time affording can be incredibly stressful. One of the greatest concerns in the current rate environment is that many Canadians won’t be able to make payments if rates go up in the next year, but you can have peace of mind knowing that a low TDS/GDS percentage should help you get through any rate increase.

Hopefully you have a better idea of your capacity to repay a mortgage now, but if you still have questions, that’s totally understandable! You can reach out to us on Twitter, Facebook, or Instagram! Otherwise check back soon when I discuss the importance of your whole credit history, not just your credit score.