Tuesday, May 8, 2012

Basing Debt Service Ratios on Gross Pay

Your Total Debt Service Ratio (TDSR) is the percentage of your gross income that covers your basic housing costs (including mortgage) plus payments on consumer debts. Most lenders prefer this to be below about 40% of your income. But does it make sense for this to be based on your gross income? After all, your tax rate increases as your income increases.

To illustrate what I mean, I calculated the percentage of gross income left over after taxes and 40% TDSR for various incomes. I assumed just the basic personal amounts for tax deductions for an Ontario resident. Here are the results:

At a $20,000 income, you’re left with about 50%, but for a $150,000 income, you’re left with only 27%. On the surface, this doesn’t seem to make sense. Shouldn’t the TDSR take into account tax levels so that the maximum TDSR permitted is lower at higher incomes?

To investigate this further, I produced a second chart that shows how many dollars are left rather than the percentage:

This chart shows that even though the percentage of income left over drops, the number of dollars left over increases. At an income of $20,000, you’ve got only about $10,000 left for other expenses, but at an income of $150,000, you’ve got about $40,000 left over.

The bottom line is that as your income increases, lenders are willing to let you allocate a higher percentage of your take-home pay to debt servicing, but they know that you’ll still have more money available for other expenses.

Personally, I find a 40% TDSR to be frighteningly high. My Own Advisor says that he’s more comfortable at 30%, and I’m even more conservative than this. Borrowers would do well to think this through and form their own opinions before blindly allowing lenders to take them to a 40% TDSR.


  1. I was surprised my wife and I even qualified for our mortgage back in 2005 since I didn't think we were making much money (were living off my investments and her salary).

    I think our payments were about 25% of her gross income, which seemed high. 40% would be a stretch for most families, I think. At that time, I didn't realize the extent to which banks "sell" money like a car dealer upsells cars.

    Having a 40% TDSR with interest rates where they are now seems dangerous indeed.

  2. @Gene: Living off your wife's salary and your passive income sounds like a good gig. I'll see if my wife will go for that. Our TDSR of 0% makes things easier.