The total debt service (TDS) ratio, defined as total debt obligations divided by gross income, is a crucial financial metric used by lenders, especially in the mortgage industry, to determine whether to extend credit. This ratio can help prospective borrowers understand how much of their gross income is already committed to debt obligations, and it can greatly influence loan approval.
The Responsibilities Factored into TDS
The housing costs in the TDS calculation include everything related to home expenses: mortgage payments, real estate taxes, homeowners’ insurance, association dues, and utilities. On the other hand, non-housing obligations, such as auto loans, student loans, credit card payments, child support, and alimony, are also considered.
Key Takeaways
- The TDS ratio is a critical metric for mortgage lenders to gauge a borrower’s capacity to handle a new loan.
- Unlike the gross debt service (GDS) ratio, the TDS ratio includes both housing and non-housing debts.
- A TDS ratio below 43% is usually required for mortgage approval; many lenders prefer it to be closer to 36%.
How TDS Ratio Works in Lending
When applying for a mortgage or any other type of loan, the TDS ratio plays a significant role in the decision-making process of lenders, equally as important as having a stable income, paying bills on time, and maintaining a strong credit score.
A lower TDS ratio enhances your chances of loan approval. Lenders look at benchmark TDS ranges, typically from 36% to a maximum of 43%, before approving loans. A ratio of 36% or less is generally preferred, and lenders rarely extend mortgages to applicants with a TDS exceeding 43%.
Example of Calculating the Total Debt Service (TDS) Ratio
Here’s a simple example to illustrate TDS calculation: If an individual has a gross monthly income of $11,000 and their monthly debt obligations total $4,225 (inclusive of $2,225 for a mortgage, $1,000 for a student loan, $350 for a motorcycle loan, and $650 for a credit card balance), you can find the TDS ratio as follows:
1TDS Ratio = Monthly Debt Obligations / Gross Monthly Income
2TDS Ratio = $4,225 / $11,000 = 0.384 or 38.4%
With a TDS ratio of 38.4%, this individual stands a good chance of securing a mortgage.
Calculate TDS Ratio in Excel
If you prefer using Excel, the TDS ratio can be easily calculated using the formula:
=SUM(debt/income)*100
In the example above, the formula would be:
=SUM(4225/11000)*100, which equals 38.4%.
Comparing Total Debt Service (TDS) Ratio to Gross Debt Service (GDS) Ratio
The TDS ratio differs from the gross debt service (GDS) ratio primarily because GDS includes only housing payments, like mortgage or rental costs, property taxes, and heating expenses. GDS does not factor in non-housing debts such as credit card payments or auto loans.
How to Achieve Optimal TDS Ratio
Ensuring a TDS ratio of no more than 43% is recommended for mortgage approval, although ideally, keeping it close to 36% enhances your approval chances significantly. This can be achieved by reducing overall monthly debt obligations or increasing gross monthly income.
Special Considerations for Loan Approval
Lenders evaluate factors beyond just the TDS ratio. For instance, smaller lenders may be flexible even if your TDS exceeds 43% under special conditions. Protect your credit score, keep debt manageable and maintain savings, all of which enhance your profile to lenders.
Monitoring and optimizing your TDS ratio strategically can make a significant difference in getting approved for a mortgage and maintaining financial health.
Related Terms: Gross Debt Service Ratio, Housing Expense Ratio, Debt Obligations, Credit Score.
