What the heck is a Total Debt Service Ratio? I think it’s edible…

Posted: February 24th, 2009 | Author: Mo2 | Filed under: Banks, Credit, Finance | Tags: bank, Budgeting, calculating TDS, Credit, Finance, TDS, total debt service ratio |

What the heck is it? Well, you may or may not have heard about it before. But take a read anyway!
Can you afford more debt?

After writing about car buying it made me want to write about how much debt an individual could afford. I don’t think too many people think about how much debt they can really have. By using the Total Debt Service Ratio (TDS hereafter) you can get a decent idea as to how much debt you can have relative to your earnings.

So how is the TDS calculated?

The TDS is calculated as follows: Monthly mortgage/rent + Property Taxes + Heating + 50% of Condo Fees + Debt Payments Divided by Monthly Gross Family Income

So that means if you’re paying $1,000 rent, $5,000 in annually property taxes, $100 for heating, and $600 for monthly debt payments and earn $6,000 a month this would mean:

=$1,000 + $416,67 ($5,000/12) + $100 + $600
$6,000

= $2,116.67
$6,000

=35.28%

Ideally you should be under 40% for the TDS. In the case above, you would be safe. This means that you can use up to 40% of $6,000 on a monthly basis, which amounts to $2,400. That means you can afford $283.33 more in debt. Obviously you shouldn’t be maxing out your debt and should be actually putting more into savings, but by knowing how much you can really afford without hurting yourself is a good place to start.

Who Looks at these Figures?
Financial institutions often use TDS to determine if you are capable of borrowing money from them. But that shouldn’t stop you from doing the calculations for yourself to help you determine your financial health. Always stay on top of your figures. That way, when the time comes to borrow money you can be well prepared and this will show the financial institutions that you are a responsible individual that can handle more debt.

Mo2 Thinks
By using the TDS it helps you budget your monthly expenses and gives you a nice round figure to determine how much debt you can carry out. Mind you, the TDS doesn’t include everyday expenses like food, cell phones, Internet connection, etc. You need to understand how much you need for those expenses and that’s why the TDS is limited to 40% because it takes into account that you will have other expenses.

When buying a car, it will most likely increase the debt that you have. While TDS is often used for bigger purchases such as a new home, it doesn’t hurt for individuals to calculate their TDS after a car purchase. This should help you determine what car you can actually afford. If you can’t handle car debt, imagine what you’ll be like with a mortgage. Yikes!

There is something else called Gross Debt Service Ration (GDS). The only difference is that with the GDS you don’t take monthly debt payments into consideration. But I like to use TDS more, but I guess you could use both. The GDS should be kept below 32%. Either way these ratios will help you determine how much debt you can have.

In North America we are starting to spend more than save. Ideally you should be saving as much as you can, but that isn’t always possible. Therefore, the first step is to control and reduce your debt. Once you have everything under control then you can start to look to save and create a worthy investment portfolio. Remember, everything requires planning and the more financial education that you have, the more it will help you in the future.

Tomorrow I will be writing about how goals and dreams are necessary and how documenting them is very important!

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