Your Debt to Income Ratio
Your debt-to-income ratio is one of the best ways to gauge whether you are in a good financial position to borrow money or if you are spending too much on debt.
In order to discover if you are in a good financial position, you must determine how much you spend each month to pay off your debts and other financial commitments. Your debt-to-income ratio is the percentage of your income you owe in debt or debt payments. Most financial experts agree a healthy debt-to-income ratio is 36 percent of your gross income.
Banks and other lending institutions use your debt-to-income ratio to gauge your ability to repay debt. If you have a low ratio, you have a better chance of repaying your debt. If you have a high ratio, you are considered a credit risk, which could prevent you from being approved for a loan or mortgage.
Gross Debt Service ratio (GDSR) and Total Debt Service ratio (TDSR) are two standard formulas used by many lenders, especially those who focus on mortgages, to analyze your ability to afford to take on additional debt. Their definitions are:
- Gross Debt Service ratio (GDSR): The rule is monthly housing costs, usually defined as mortgage payments (combined principal and interest) plus property taxes, secondary financing, heating and 50% of condominium fees, if applicable, should not exceed 32 per cent of monthly household income before taxes.
- Total Debt Service ratio (TDSR): this calculation compares monthly income to housing costs (same as GDSR) plus payments on lines of credit, credit cards and other debt. Housing costs plus debt payments shouldn’t exceed 40 per cent of income.
As well, lenders will take into consideration your record in repaying previous debts and how long you’ve been at your current job.
It is important to find out what your debt to income ratios are and if you can afford to increase your debt load. This is a first step to knowing whether you are potentially in financial trouble.
The calculator is a valuable tool to help determine whether your ratio is acceptable or too high to borrow money.
Understanding your debt-to-income ratio
36% or less : This is the ideal amount of debt for most people to carry.
37%-42% : At this level start reducing spending now before you dig yourself further into debt.
43%-49% : Financial distress is right around the corner unless you act quickly to prevent it.
50% or more : You need professional assistance to severely reduce your debt.
Dealing with a High Debt to Income Ratio
If your debt-to-income ratio is too high, don’t panic. There are two obvious options, lower your monthly debts (cut back on the use of your credit cards) or increase your income. We know this is not as easy as it sounds, but to improve your money management skills you will have to make changes. The easiest way is to stop the frequent use of your credit cards. Put them away.
If you're concerned about your credit management, we can help. Our first step would be to prepare a free budget & debt analysis for you. Take into account everything you spend money on – coffee in the morning, filling up your gas tank, restaurant visits, shopping at the mall. You may surprise yourself at how changing your habits will help you reduce your debt.
Take responsibility of your finances -- discover your own spending habits, how to make smarter purchases, educate yourself and you will lower your debt-to-income ratio.
Contact Consolidated Credit Counseling Services of Canada, Inc. at 1-888-287-8506 or click on the link for a free debt & budget analysis. Our professional, specially trained credit counsellors are here to help you live debt free and financially independent.
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