You have applied for a mortgage.

Your credit score is good. You make payments on time. You have a good credit history, and there are no negative credit remarks on your credit report.

Somehow, the bank refuses your mortgage, and you’re wondering why!

Your debt-to-income ratio might be the culprit.

As per the latest findings of Statistics Canada, the ratio between the household credit market debt and household disposable income has reached 176.9%, indicating a credit market debt of $1.77 against $1 in disposable income.

Another US study reveals that debt-to-income ratio is the top reason for mortgage denials, especially for people living in expensive cities. Over 26% of mortgage applications are denied because of a high debt-to-income ratio followed by credit history (24.21%), incomplete application (17.04%), insufficient collateral (16.02%), among other reasons.

We have put together this post to discuss the debt-to-income ratio and how it affects your mortgage approval rates.

What is debt to income ratio?

Your debt-to-income (DTI) ratio compares your expenses to your monthly income. It’s fairly simple to calculate.

Start by adding all your monthly debt payments, including car loans, personal loans, credit card payments, or any other kind of debt, along with rent or homeownership expenses, such as mortgage principal, insurance, property taxes, interest, or any other fees.

Now, divide your net debt payments by your monthly income (gross). That should give you your DTI (multiply it with 100).

Let’s take an example.

Net debt: $1,500

Monthly income: $6,000

Debt-to-income ratio: 25%

Two types of debt to income ratio: Front-end and back-end

There are two types of debt-to-income ratios.

The front-end DTI ratio involves your housing expenses in the calculation, just like we did in the example.

The back-end DTI, on the contrary, doesn’t include your housing expenses. Most lenders look at your back-end DTI ratio when checking mortgage eligibility.

Why do lenders check your debt to income ratio?

Your DTI ratio plays a critical role in your mortgage eligibility. It gives lenders a fair idea of your current obligations and your ability to repay a loan. Ideally, you would want to have a lower DTI to qualify for a loan.

What is a good debt to income ratio in Canada?

The ideal debt-to-income ratio varies among financial institutions.

If you’re seeking a conventional mortgage, your DTI ratio should be below 40% to qualify for a mortgage, as per the regulatory guidelines.

However, one must note that most financial institutions would want a DTI ratio of 36 or below.

In addition to DTI, lenders will also look at your gross debt service (GDS) ratio, which includes mortgage payments, condo fees (up to 50%), heating, and property taxes. Your GDS ratio should be below 32%.

How to improve your debt to income ratio?

The good news is that you can improve your DTI by lowering your current levels of debt.

There are two ways of lowering your DTI:

  • Reduce your debt
  • Grow your income.

You can start repaying short-term loans, such as personal loans or credit card debt. Student loans or mortgage payments may take time to repay, so focussing on short-term loans is a good strategy.

The second option is to increase your income. You can either seek a raise at your job or take a part-time employment opportunity. Doing either will help you dedicate more resources towards debt payment while improving your DTI.

If you’re planning to apply for a mortgage, consider calculating your DTI before sending an application. You don’t want to be caught off-guard!