Total Debt Service (TDS) Ratio Demystified: Practical Calculation and Example
Understand the Total Debt Service (TDS) ratio, learn how to calculate it, and gain clarity through a practical example.
The Total Debt Service (TDS) ratio is a financial metric used by lenders to assess a borrower's ability to manage their debt obligations. It represents the percentage of a borrower's gross income that is needed to cover all debt payments, including housing-related expenses and other outstanding debts. Here's how to calculate the TDS ratio and provide a practical example.
TDS Ratio Calculation:
To calculate the Total Debt Service (TDS) ratio, follow these steps:
Determine Monthly Debt Payments: Start by summing all your monthly debt payments, including mortgage or rent, property taxes, homeowners or renters insurance, credit card payments, auto loans, student loans, personal loans, and any other financial obligations.
Calculate Gross Monthly Income: Determine your gross monthly income, which includes your salary, wages, rental income, self-employment income, alimony, and any other sources of regular income.
Calculate TDS Ratio: Use the following formula to calculate the TDS ratio:
Multiply the result by 100 to express the ratio as a percentage.
Practical Example:
Let's consider a practical example to calculate the TDS ratio:
- Monthly mortgage payment: $1,500
- Property taxes: $300
- Homeowners insurance: $100
- Car loan payment: $350
- Credit card payments: $200
- Gross monthly income: $5,000
Total Monthly Debt Payments:
- Mortgage payment + Property taxes + Homeowners insurance + Car loan payment + Credit card payments
- $1,500 + $300 + $100 + $350 + $200
- Total Monthly Debt Payments = $2,450
TDS Ratio Calculation:
- TDS Ratio = (Total Monthly Debt Payments / Gross Monthly Income) × 100
- TDS Ratio = ($2,450 / $5,000) × 100
- TDS Ratio = 49%
In this example, the TDS ratio is 49%. This means that 49% of the borrower's gross monthly income is dedicated to covering debt payments. Lenders typically have specific TDS ratio limits that borrowers must meet to qualify for a loan. These limits vary depending on the type of loan, the lender's policies, and prevailing market conditions. A lower TDS ratio is generally more favorable because it indicates that the borrower has a smaller proportion of their income committed to debt payments, leaving more room for other expenses and savings.
It's essential for borrowers to be aware of their TDS ratio when considering new loans, as exceeding a lender's specified limit can affect loan eligibility. Maintaining a manageable TDS ratio is crucial for healthy financial management and avoiding overextending yourself with debt.
What Is Total Debt Service (TDS) Ratio? Example and Calculation.
The total debt service (TDS) ratio is a financial metric that measures a borrower's ability to repay their monthly debt obligations. It is calculated by dividing the borrower's total monthly debt payments by their gross monthly income.
Formula:
TDS ratio = (Total monthly debt payments) / (Gross monthly income)
Example:
A borrower has a monthly mortgage payment of $1,500, a car payment of $300, and a credit card payment of $200. Their gross monthly income is $4,000.
To calculate their TDS ratio, we would divide their total monthly debt payments by their gross monthly income:
TDS ratio = ($1,500 + $300 + $200) / $4,000 = 50%
This borrower has a TDS ratio of 50%, which means that they are spending 50% of their monthly income on debt payments.
Interpretation:
A higher TDS ratio indicates that the borrower is spending more of their income on debt payments. This can make it difficult to save money or cover unexpected expenses. Lenders typically prefer to see a TDS ratio of 35% or less.
How to reduce TDS ratio:
There are a few things that borrowers can do to reduce their TDS ratio:
- Increase income: This could involve getting a raise at work, starting a side hustle, or getting a second job.
- Pay down debt: This could involve making extra payments on debt or consolidating debt into a single loan with a lower interest rate.
- Reduce expenses: This could involve cutting back on unnecessary spending or finding ways to save money on essential expenses.
If you are struggling to manage your debt, it is important to seek professional help. A financial advisor can help you to develop a budget and create a plan to reduce your debt and improve your financial situation.