How is debt-to-income ratio calculated?

16 April 2021 by National Bank
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Is your goal to buy a home? Knowing your debt-to-income ratio could allow you to determine if you’re well-positioned to take out a loan. This ratio is calculated by banks to evaluate your debt load. By calculating it yourself, you’ll be able to see if you’re living above your means, and if you should change your habits to get the funds you need for your goal. Here’s some advice.

What is the debt-to-income ratio?

The debt-to-income ratio is a percentage that evaluates your debt compared to your gross income. This ratio allows you to determine how much you owe for every dollar earned.

The lower your debt-to-income ratio, the more reasonable your debt load, and the better your ability to repay. This indicator is an estimate of your ability to keep taking care of your debt and your expenses, on top of paying off a future mortgage.

The bank will take this number into account to ensure that your new loan corresponds with your ability to repay.

How is the debt-to-income ratio calculated?

The debt-to-income ratio can be calculated using these two formulas:

Gross debt service ratio (GDS)

This corresponds to the percentage of your gross income that goes towards housing fees for the home you’re looking to buy. Generally speaking, you need a GDS between 32% and 39% to get a loan, but your bank may require a lower ratio.

To calculate it:

1. Add up your monthly occupancy expenses: Mortgage payments + municipal taxes + school taxes + heating and electricity + 50% of the condo fees (if applicable).
2. Multiply the total by 100.
3. Divide the new total by your gross monthly income.

Total debt service ratio (TDS)

This is the percentage of your gross monthly income that goes towards housing fees for the home you’re looking to buy, in addition to your other debts. Your TDS shouldn’t exceed 44%, but a lender may require a lower ratio. Usually, a TDS under 40% is good enough to get a loan.

To calculate TDS:

1. Add up your monthly occupancy expenses: Mortgage payments + municipal taxes + school taxes + heating and electricity + 50% of the condo fees (if applicable).
2. Add your other monthly financial commitments to this total: Loans, typically 3% of the limit on each of your credit cards and lines of credit (whether you carry a balance or not), child support and alimony, as well as any other debt payments.
3. Multiply the total by 100.
4. Divide the new total by your gross monthly income.

Food and service charges, like your cell phone, Internet or cable bills, aren’t included in this calculation as these expenses don’t generate debt. Generally speaking, experts agree that this calculation produces a better overview of your situation, as it takes into account your current expenses.

To calculate these ratios, you can use the Canada Mortgage and Housing Corporation’s debt service calculator.

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If I have a high debt-to-income ratio, will I be turned down automatically?

These ratios are indicators of the position you typically need to be in to get financing. If your debt-to-income ratio is too high, you may be turned down. However, depending on your financial situation, you may still qualify for a loan.

Your file will be examined by your bank in order to evaluate your situation and your profile as a whole, taking into account several elements such as:

● How much do you make?
● What field do you work in?
● How long have you been in your current job?
● Why are you applying for a loan?
● What are your assets and your liquidity?
● How is your credit report?

A lender could also ask you to find a co-borrower or an endorser in order to reduce the risks related to granting you a loan.

If you want to get a loan, you should not exceed the limits on these ratios; they are critical thresholds, and indicators of a high debt load. Getting close to that maximum – not to mention exceeding it – is dangerous. You may find yourself in a precarious situation if an unexpected event should arise, like if you’re faced with unexpectedly high interest rates, lose your job, or encounter a health issue.

How do I lower my debt-to-income ratio?

Is your debt-to-income ratio over 50%? This may be a sign that you’re living above your means.

To make getting a mortgage loan easier, you could figure out how to pay off your debt. Here are a few things you could do:

Make a budget: Having an overview of your monthly income and expenses will allow you to determine how much money you can put towards paying off your debt, even if you’re only paying off a little at a time. To put the odds in your favour, review your budget regularly, spend reasonably, and consider whether a major expense that will increase your debt load is really something you need.
Prioritize your debts: List the totals of all your debts, as well as their interest rates. Pay off debts with a high interest rate first, as these are usually the most expensive. You can also prioritize paying off “bad” debt, meaning loans taken out to make purchases that will quickly lose value, rather than “good” debt, which is considered an investment, or debts whose interest is tax deductible, such as student loans.
Consolidate your debt: To make payments easier and potentially get a lower interest rate, you could ask the bank for a loan in order to consolidate all your debt. On top of having only one monthly payment to make, this could also have a positive impact on your budget and borrowing capacity. Talk it over with an advisor.

Increasing your income is another way to improve your debt-to-income ratio if you’re planning on buying a home. Getting an additional source of income will also allow you to pay off your debt faster.

People who reach these ratio limits find themselves in a cycle of debt. If you think you have financial issues and need help, read these tips on helping you take control of your financial situation.

Knowing the limits of “acceptable” debt loads will allow you to avoid being on the verge of financial trouble. After you’ve purchased a home, will you still be able to travel, go out, and save?

With a good debt-to-income ratio, you’ll be in a better position to not only get a loan, but also make your mortgage payments, pay off your other current commitments, and afford any new expenses related to buying a home. We’re here to answer your questions.


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