How do you calculate whether you can take on the monthly payments associated with a significant purchase? How do financial institutions do it? And, most importantly, what is an appropriate level of debt?
Your total debt service ratio (TDSR)
Lenders calculate your TDSR to determine either how large a loan or how large a mortgage they are willing to advance to you. To arrive at your TDSR, they add up your monthly mortgage and consumer debt payments (credit card payment, line of credit payment and car payment, for example) and then divide that total by your gross monthly income. Generally, they limit this ratio of total debt to
gross income to 35%.
Some lenders will allow your TDSR to be as high as 40% of your gross monthly income, but as a borrower, you should think twice about taking on even the lower amount of debt, especially when your debt has to be repaid with after-tax, not pre-tax dollars.
Debt warning signs
The challenge is that indicators like the TDSR don’t give you an accurate assessment of how much debt you can realistically afford. This can result in people getting in over their heads before they realize it. Here are some specific signs of trouble
- You have one or more credit cards on which you never make more than the
minimum payment each month.
- You can’t keep track of your monthly payments.
- Your line of credit is maxed.
- You depend on overdraft protection.
- You have no money for emergencies.
Your best guide — a personal budget
Ideally, it’s you, not a lender, who should understand how much you can afford to spend each month. Although some people think that if a financial institution will advance them a certain amount of credit, they must be able to afford it — that often isn’t the case. For many people, taking on a maximum amount set by a lender means living a very frugal lifestyle, which can be tough to sustain in the long term.
The best way to determine what you can afford to pay for that new house or car is by monitoring what you spend each month. If you keep an accurate personal budget for at least several months, you will have an understanding of how much money you require to live a lifestyle that is acceptable to you.
If your budget reveals that you need to get a handle on your finances, you have already taken a good first step in understanding where your money is going. Then you can work to regain control.
We can help. Your Investors Group Consultant can work with you to identify good and bad debt, and can create a consolidation plan with affordable payments that will help you get back on track to achieving your financial goals.
This newsletter, specifically written and published by Investors Group, is presented as a general source of information only, and is not intended as a solicitation to buy or sell specific investments, nor is it intended to provide legal advice. Clients should discuss their situation with their Consultant for advice based on their specific circumstances.
Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.
I.G. Investment Management Ltd. is a licensed mortgage broker, Investors Group Trust Co. Ltd. is a trust company licensed to lend money in all jurisdictions in Canada. Clients with mortgage inquires will be referred to an Investors Group Mortgage Planning Specialist.
For more information Email consultant, Dave.Pavelich@InvestorsGroup.com
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