How to Improve Your Debt-to-Income Ratio Before Applying for a Mortgage

Buying a home is a considerable financial decision you will make. Getting mortgage approval in Canada’s competitive real estate market is quite tricky. Your debt-to-income ratio (DTI) is the main consideration used by the lenders. It fundamentally evaluates the percentage of your earnings that is spent on debt settlements.

A high debt-to-income ratio can damage your possibility of obtaining a mortgage or might lead to a higher interest payment that will raise the cost of your property even more.

There are luckily several known strategies to reduce your debt-to-income ratio. They could increase your chances of getting a mortgage with good terms.

Let’s have a look at them below:

Understanding Debt-to-Income Ratio in Canada

Your debt-to-income ratio is a major financial metric that lenders check to understand your borrowing capacity.

In Canada, mortgage lenders focus more on two key DTI calculations:

Gross Debt Service (GDS) Ratio

It measures how much of your gross monthly income is used for housing-related costs:

• Mortgage principal and interest
• Property taxes
• Heating costs
• 50% of condo fees (if applicable)

The maximum Gross Debt Service (GDS) ratio which is recommended by the Canadian Mortgage and Housing Corporation (CMHC) is 39%.

Total Debt Service (TDS) Ratio

It considers all of your debt obligations like:

• Mortgage costs (as calculated in GDS)
• Car loans or leases
• Credit card payments
• Student loans
• Personal loans or lines of credit

The maximum Total Debt Service (TDS) ratio which is recommended by the Canadian Mortgage and Housing Corporation (CMHC) is 44%.

According to Statistics Canada, as of Q4 2023, the average Canadian household debt-to-income ratio was 184.5%, meaning Canadians owed $1.85 for every $1.00 of disposable income.

Increase Your Income to Strengthen Your DTI

Do you know that an increase in your income can help lower your debt-to-income ratio? Let’s see how:

• If you have been doing your job well, you can ask for a salary increment. A 2023 Robert Half Canada report found that 48% of professionals who asked for a raise received one.
• Many Canadians supplement their income with freelancing, consulting, or selling products online. According to BMO, 44% of Canadians have a secondary income source.
• In Toronto, renting out a basement suite can help generate $1,500–$2,000 per month which can significantly lower your DTI.
• Lastly, dividend-paying stocks, rental properties, and high-interest saving accounts like EQ Bank’s 2.5% savings rate can provide extra cash flow.

The lenders in Canada prefer stable and predictable income. So, if you have consistent earnings from employment or documented side income can strengthen your mortgage application.

Reduce Existing Debts (Especially High-Interest Ones)

The most effective way to lower your DTI is by reducing your existing debts. The lenders assess your ability to handle new mortgages based on your existing financial commitments. Hence, lowering your outstanding debt can significantly improve your mortgage approval chances. Focus on high-interest debt first.

Like credit cards with 19.99%+ interest rates, a $5,000 balance at 20% costs $1,000 yearly in interest. Consolidating $10,000 from 20% to 7% lowers payments and speeds up repayment. Avoiding new debt like a $500 car loan could reduce mortgage affordability by $100,000 or so. Pay down existing debts instead.

Reduce Monthly Expenses to Free Up Cash

We all know that cutting unnecessary expenses is a simple yet effective way to reduce debt and improve your debt-to-income ratio. Even the small reductions can help you in that and make a big difference over time. Also, track your monthly expenses and create a budget. It will help you monitor where your money is going. Well, housing costs are often the biggest expense for Canadians.

For example, renting a one-bedroom apartment in downtown Toronto costs around $2,500 per month but you could save $500–$1,000 monthly by just moving outside the city. By reducing unnecessary expenses and redirecting savings toward debt repayment, you can improve your DTI quickly and increase your mortgage approval chances.

Avoid Large Purchases Before Applying for a Mortgage

Most of the time many home buyers make the mistake of taking out a new loan before applying for a mortgage. They don’t realize how much it can affect their approval. New loans can significantly raise your DTI even if you have a stable income. If you want to protect your mortgage approval then delay major purchases until you secure your home loan.

Similarly, large financial purchases on credit cards like furniture or vacation raise your credit utilization which can drop your credit score by 20-30 points if you max out a $10,000 limit. Also, the lenders perform a final credit check before closing so new loans can jeopardize approval or may cause delays.

For example, if you take out a $40,000 car loan with a $700 monthly payment, your TDS ratio increases which reduces the amount a lender is willing to approve for your mortgage. This single purchase could lower your mortgage approval amount by $150,000 or more.

Improve Your Credit Score for Better Mortgage Rates

Your credit score affects mortgage interest rates which influences the affordability even if it doesn’t directly impact your DTI.

Here are some steps to boost your credit score:

• Pay All Bills on Time: One late payment alone can drop your score by 50 points.
• Keep Credit Utilization Low: Try to keep your credit utilization ratio below 30%.
• Check Your Credit Report: Get a free credit report from Equifax Canada or TransUnion.
• Avoid New Credit Applications: A new credit card application results in hard inquiry and lowers your score.

With a credit rating of 680+, you are eligible for top mortgage rates, which could save you tens of thousands of dollars in interest over the life of your loan.

Final Thoughts

A low debt-to-income ratio is mandatory for mortgage approval and securing the best mortgage with the best loan terms in Canada. You can improve your financial health and maximize your home-buying power by increasing your income, paying off debt, cutting expenses, avoiding new loans, and maintaining a strong credit score.

If you are looking for expert guidance on mortgage approval, Max Mortgages Inc. can help you in that process. We offer custom mortgage solutions based on your financial circumstances.

So, contact us today to strengthen your finances and secure the best mortgage for your dream home!