I’ve heard these terms thrown around by a few financial institutions from time to time. Here is a quick look and my quick take on them:
- Gross Debt Service Ratio (GDSR) – % income required to pay basic housing costs.
Under the “basic” banner: mortgage payments (including principal and interest), condo fees (if you have any), property taxes and heating costs. This sum is divided by your total gross income. Financial institutions want to see your GDSR under 32%. This is because spending more than 32% on “basic” housing costs could make it difficult to cover other expenses. If you exceed 32%, your mortgage application or loan amount would likely be declined.
- Total Debt Service Ratio (TDSR) - % income required to cover basic housing costs and all other consumer debts.
This is a percentage of your gross monthly income used for housing and other outstanding loans and debts. Financial institutions want to see your TDSR under 40%, although lenders will usually allow clients to borrow up to this limit. It would be rare however, if a financial institution would loan money to folks with a TDSR higher than 40%. Do they?
The struggle I have with GDSR and TDSR is your gross income is your income before deductions. Gross income is before income taxes, Canada Pension Plan (CPP) and Employment Insurance (EI) premiums and other premiums such as workplace benefits. For me (and probably for you?) these deductions account for least 30% of my gross income or in other words, income I never see. While I could rationalize why creditors and institutions would use gross income as the baseline for service ratios, as a debt-holder it doesn’t make any sense to me. Both ratios are simply way too high for me and border on scary. With about 70% or less of my take-home pay available to service various debt, I want my total debt ratio under 30% using net income as my denominator. Personally, I’d like to get my total debt ratio under 20% within the next 5 years. This debt would include not only my outstanding mortgage but also any car payment. No line of credit, no credit card debt, nothing else.
As a 30-something saving and investing his way out of debt towards financial freedom that’s a much more comfortable debt ratio I could live with.
What about you?
Have you ever taken a deeper look at these debt service ratios as they relate to your personal finance situation?