Total Debt Servicing Ratio

Total Debt Servicing Ratio

In business finance, there exists a variety of metrics that help gauge an individual or company’s financial health. The Total Debt Servicing (TDS) Ratio is one such essential metric that plays a pivotal role in financial decision-making. A lower TDS Ratio signifies better financial stability and increased access to credit, making it an essential tool in managing your financial well-being.

What is the TDS Ratio? 

The TDS Ratio is a financial metric used to assess an individual or entity’s ability to manage and service their existing debts effectively. It is an indispensable tool for lenders, creditors, and borrowers alike. TDS takes into account all recurring debt obligations, including mortgage payments, car loans, credit card bills, and other debts, relative to the borrower’s income. 

In essence, it measures the percentage of a person’s or company’s income that is allocated towards servicing debts. A lower TDS Ratio is generally more favourable, as it signifies a smaller portion of one’s income going towards debt repayment, indicating better financial stability. Conversely, a higher TDS Ratio signifies a higher debt burden, which may pose a risk to your financial health 

Understanding TDS Ratio 

Understanding the TDS Ratio is crucial because it helps you assess your financial capacity to take on more debt, such as a mortgage or a business loan. It reflects how much of your income goes toward paying off existing debt, leaving you with a better grasp of your financial stability. 

The TDS Ratio is essentially a percentage that reveals how much of your monthly income is allocated to servicing existing debts, including mortgages, car loans, credit card payments, and other financial obligations. The lower this percentage, the more financially secure you appear to potential lenders. 

To compute your TDS Ratio, simply add up all monthly debt payments and divide this by your gross monthly income, then multiply the result by 100. A lower TDS Ratio indicates better financial health and an increased likelihood of securing credit or loans.

Working of TDS Ratio. 

If the TDS Ratio is too high, it can signal that you might struggle to meet your financial obligations, which can result in financial stress or even default. Lenders typically use this ratio to determine your eligibility for credit, as a lower TDS Ratio suggests a lower credit risk. 

TDS works by evaluating the proportion of one’s income dedicated to servicing these obligations. It operates on a simple premise: the lower the TDS Ratio, the better. To calculate it, one must sum all monthly debt payments, such as mortgages, car loans, and credit card bills, and then divide this by the gross monthly income. The result is expressed as a percentage, which represents the share of income allocated to debt servicing. 

Calculation of Total Debt Servicing Ratio 

The formula for calculating the TDS Ratio is straightforward: 

TDS Ratio = (Total Monthly Debt Payments / Gross Monthly Income) x 100 

Here’s a breakdown of the key components: 

Total Monthly Debt Payments: This includes all your monthly debt obligations, such as mortgage or rent, car loans, credit card minimum payments, student loans, and any other recurring debts. 

Gross Monthly Income: This represents your total monthly income before taxes and deductions, including salary, bonuses, rental income, and any other sources of income. 

The resulting ratio, expressed as a percentage, reflects the proportion of your income devoted to servicing your debts. 

Examples of TDS Ratio

Let’s illustrate the TDS Ratio with a couple of examples: 

Example 1: Personal Finance 

In this example, an individual’s Total Monthly Debt Payments amount to US$1,500, which includes various financial commitments like credit card payments, car loans, and student loan instalments. The Gross Monthly Income is US$5,000, representing the earnings before taxes and deductions. 

The calculated TDS Ratio of 30% indicates that this individual allocates 30% of the monthly income to servicing the debts. This leaves him with 70% of the income available for other expenses, savings, and discretionary spending. A TDS Ratio of 30% generally suggests good financial health, as it signifies that the majority of the income is not excessively burdened by debt payments. 

 Example 2: Mortgage Application 

In the context of a mortgage application, a TDS Ratio of 30.77% reveals that the applicant is dedicating nearly 31% of the monthly income to servicing  existing debts, including credit card payments, car loans, and student loans. This percentage is calculated based on the Total Monthly Debt Payments of US$2,000 and a Gross Monthly Income of US$6,500. 

For mortgage lenders, a TDS Ratio plays a crucial role in the decision-making process. In this scenario, the TDS Ratio of 30.77% may be a determining factor when assessing the applicant’s eligibility for a mortgage. Lenders are often cautious about approving mortgages for individuals with high TDS Ratios, as it suggests a significant portion of the income is already committed to debt servicing. It may raise concerns about the ability to manage the additional financial burden of a mortgage. Therefore, it’s advisable for mortgage applicants to aim for a lower TDS Ratio to improve the chances of loan approval and to ensure he can comfortably meet all the financial obligations. 

Frequently Asked Questions