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Debt Service Ratio. What Is It and Why Should It Matter to You?

  • Financial Education
06 Mar 2020
Debt Service Ratio. What Is It and Why Should It Matter to You?

In short, Debt Service Ratio (DSR) essentially represents the percentage of your monthly income, or cash flow, from which you make all your monthly debt payments. It is one of the most important criteria lenders use to determine your ability to repay a loan.

Debt service ratio is calculated as a percentage figure and if it is too high, it means you are more likely to struggle to meet your monthly loan payment obligations. This struggle becomes even more difficult when, in addition to making normal monthly payments, you are faced with unexpected expenses such as car repairs or medical bills.

This chart shows an example of how debt service ratio is calculated:

The two key factors used to calculate debt service ratio are total debt commitments and total disposable income.

Total Debt Commitments
This includes all payments used for monthly debt commitments such as rent, mortgage, credit cards, and other loans—including the NEW loan payment. It is important to note that the monthly credit card payment estimate is based on a percentage of the total credit limit (for example, 5%).

Total Disposable Income
This is calculated by adding all salary and other income (example: income from property rentals, side business or part-time jobs) and then subtracting all statutory deductions like pension, health, and home insurance/strata fees. The result is the amount of money from which your pay normal living expenses, debts and any unforeseen expenses.

This chart shows an example of how disposable income is calculated:

In summary, maintaining a low debt service ratio will ensure that when you apply for loans, there is a better chance the lender will grant it. This chance, or credit risk in financial terms, is fundamental in the loan approval process, because it represents the likelihood that the lender will lose money when a member defaults or fails to repay their loan or meet contractual obligations.

Stay tuned for our next story in this series when we delve deeper into credit risk and why a lender must consider it.

For more information about debt service ratio and to request assistance on calculating yours, please contact our Loans Department at 815-4222 or 815-4231; loans@cicsacu.com.ky.