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How is debt-to-income ratio calculated?

27 January 2015 by National Bank
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Anyone who has followed the economic headlines in recent years has heard plenty of concern being raised over Canada’s burgeoning debt-to-income ratio. For many, the figure is alarming, yet they don’t know what their own debt-to-income ratio actually is. But don’t worry if you find yourself in that majority, since even economists differ on what it really should be.

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Controversial figures

Canada’s overall debt-to-income ratio provides a snapshot of what the average Canadian family owes, versus household income. However, some methods calculate total family debt to net income, while others compare income figures to debt payment. The figure exceeded 163% in the third quarter of 2013, according to some calculations, while other methodologies placed the figure at more like 150%. Nevertheless, with mortgage borrowing at more than $1.1 trillion nationwide, the nation’s debt-to-income ratio is worrisome.

“The debt-to-income ratio in Canada is definitely a concern and it is increasing,” confirms Carl Lamoureux, Senior Manager, Credit Risk at National Bank of Canada. “But sometimes the media focuses on controversial measurements, without looking at the asset side of the equation for a wider view of what is going on.”

Breaking down debt-to-income ratios

In fact, debt-to-income ratio doesn’t tell the whole story and is only one small piece of detailed financial situations. That being said, knowing your debt-to-income ratio in advance of requesting a loan can be advantageous…if it’s a good result!

There are a variety of factors to consider when assessing debt-to-income ratio, including:

  • Front ratio: Includes all housing costs;

  • Back ratio: Non-mortgage debt-to-income ratio.

For each of the above ratios, lenders will vary in the percentage scores they deem to be favourable, or risky.

Client-based ratios

The debt-to-income ratio figures that we read about every day try to paint a picture of the total debt of all Canadians, versus total income. However, from an individual consumer perspective, calculations such as your Total Debt Servicing (TDS) ratio may be more beneficial.

“When you are looking for a new loan, credit bureau information comes first and your debt-to-income ratio is only one of the things they look at,” explains Lamoureux. “Each part of a credit score provides insight into a predictability of something happening in the future, and your TDS is a solid indicator of your borrowing capacity.”

When it comes to looking for a mortgage loan, most lenders will cap non-risk TDS at 40%, meaning that all housing costs and other monthly debt payments should not be more than 40% of your gross monthly income. Another calculation applied to mortgage loan requests is a borrower’s Gross Debt Service ratio, which measures all housing costs as a percentage of gross monthly income. According to Canada Mortgage and Housing Corp., a consumer’s GDS ratio should not exceed 32% of gross household monthly income.

To calculate your own TDS and GDS ratios, visit the CMHC website.

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