Home > market analysis, personal finance, real-estate > Affordability, GDS, TDS, personal income – gross vs disposable

Affordability, GDS, TDS, personal income – gross vs disposable

All financial institutions and creditors use Gross Debt Service & Total Debt Service (GDS & TDS) ratios when evaluating a potential borrower for a mortgage… and at least use the TDS for all other personal loans i.e. personal line of credit, credit card, an auto-loan, a mortgage, and the kitchen sink, etc (except student loans)

Here is a short definition of GDS & TDS:

Gross Debt Service (GDS): The percentage of the borrower’s gross monthly income that is needed to pay all required monthly housing costs (mortgage payments, property taxes, heat and 50% of condo fees).

Total Debt Service (TDS): The percentage of the borrower’s gross monthly income that is needed to cover housing costs (GDS) plus any other monthly obligations that an individual has, such as credit card payments and car payments.

According to personal finance rules of thumb, courtesy of CMHC:

  • Max GDS = 32%
  • Max TDS = 40%

What is my point?

Why do creditors use gross personal income and not your after tax income or your take home pay? After all, the cost of borrowed money i.e. interest is not tax deductible in Canada (with a few exceptions)… which means that you service your debt payments from your after tax salary i.e. your take home pay and not your gross salary!

Perhaps there is a simple answer…?

Why does it matter? Because…

Using gross income in any affordability measure overstates the affordability by the tax rate… and gives the false perception that that debt is affordable when it reality it is not. The government is not going to reduce your tax so you can pay your debt (unless you are a bank)!

After every new housing affordability report in the last year, CREA has been quick to announce that housing in Canada is more affordable than ever? Really? If you believe you the horn tooting dimwits at CREA, I don’t know who can help you!…I have talked about housing affordability measure before

On to greener pastures

A recent household debt report from TD squarely puts things into perspective… I have put together a chart of Debt-to-Income & House Price-to-Income ratio vs Bank of Canada rate using the TD data…

Source: Bank of Canada, TD Bank


Note that TD uses personal disposable income in both the ratios above…

See the trend… inverse correlation between Debt-to-income/House Price-to-Income and Interest Rates? Here is the correlation matrix:

BOC Rate (left) Debt-to-Income (right) Home Price-to-Income Ratio (left)
BOC Rate (left) 1
Debt-to-Income (right) -0.57808 1
Home Price-to-Income Ratio (left) -0.49056 0.809653 1

As debt becomes cheaper (lower interest rates), demand for debt increases (green line)… isn’t that econ 101? Not sure how ugly it will be when it debt becomes expensive… relatively

As it becomes easier to get debt, debt financed assets i.e. homes increase in demand & price (purple line)

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