The Learning Centre:
The debt-to-income ratio: what it is and how to reduce it
Oscar Wilde once said, “Anyone who lives within their means, suffers from a lack of imagination.”
However, according to Statistics Canada, the current national debt-to-income ratio is $1.78 for every dollar of income earned. You could say that in our modern-day, ‘post-Wilde’ world, it actually takes a greater amount of imagination to live within one’s means.
With each passing year, the debt-to-income ratio continues to climb. This means Canadians are not just living beyond their means—they’re continuing to spend well beyond them.
That’s where learning more about your debt-to-income ratio (DTI) can help keep spending in check.
The easiest way to understand your DTI is to think of it as a scoring system. However unlike a credit score—where higher equals better—you want your DTI to be as low as possible.
Ideally, you should aim to keep your DTI below 36% in order to be considered low risk.
Anything below 36% puts you in a better position to be approved for large-scale loans such as mortgages and lines of credit. Whereas anything between 37% and 49% is considered by financial institutions to be ‘high-risk’.
If you’re lower on the pay grid, be especially mindful of where you fall on the DTI spectrum.
While it might be tempting to use credit cards as a way to bridge any income gaps, racking up a high amount of debt during a time in your career when you’re typically earning less could push your DTI into high-risk territory. This could result in having to deal with an alternative lender in order to secure a mortgage or loan, as they usually take on riskier borrowers, but also tend to have higher interest rates.
While your DTI provides you with a helpful ‘debt snapshot’, keep in mind it may also not give you the full picture. This is where two other ratios come in.
- Gross Debt Service ratio (GDS): The percentage of your income needed to pay your monthly housing costs, including principal and interest on mortgage payments, taxes, heat/utilities, as well as 50% of condo fees (if applicable)
- Total Debt Service ratio (TDS): This is the percentage of your income needed to cover all of your debt, including shelter, car payments, credit cards, loans, alimony (if applicable)
While debt servicing hasn’t been as much of an issue in the past (when interest rates were at their lowest), you can bet lenders are paying closer attention to GDS/TDS ratios in today’s environment of rising interest rates. Particularly considering that while both interest rates and debt loads have been getting higher, national average income levels have pretty much remained flat.
Calculate your GDS and TDS ratios by visiting the CMHC website, here.
If you’ve calculated your ratios and find that you’re in a high risk position, here are 3 easy ways to get things back under control:
#1: Consider transferring high-interest credit card debt to a low-interest card (if available).
According to Educators’ Financial Kickstart Challenge, 25% of education members keep a balance on their credit cards.
If you have no choice but to carry a balance on your high-interest credit card, it might make sense to transfer that balance to a low-interest card instead. Especially when you consider that standard credit cards have an average interest rate of 19.99%, whereas balance transfer cards tend to offer rates that are far lower. While balance transfer cards don’t typically offer perks such as cash back or reward miles, the lower interest rates they offer means more of your money will go towards paying down the principal—reducing your debt-to-income ratio, faster.
#2: Suspend (or limit) the amount of additional debt you take on.
Whenever you’re tempted to spend beyond your means, just remember that every dollar you add in debt is an added step away from reducing your DTI. This means you’ll have to dig deep within yourself to differentiate between your wants versus your needs. The more you can sacrifice those wants in the short-term, the bigger the financial pay off in the long-term.
If you do have to take on additional debt, give careful consideration to the terms of that debt.
For example, let’s say your car breaks down and you have no choice but to finance a new car. While it might be tempting to take the 7- or 8-year term offered by the dealership (because longer terms equal lower monthly payments), just remember that the longer the term, the more you’ll be paying in interest.
#3: Put any extra money you have towards paying down your debt.
Whether you’re getting money back on a tax return or discover that you have a little extra leftover in your monthly budget, put every dollar you can towards paying down your debt before spending that money on anything else.
If you can only afford to make the minimum monthly payments, try to make them twice (versus just once) a month. You’ll be paying more towards the principal and reducing the amount of interest, helping you clear that debt off faster.
If you’re in the first few years of your education career, you may still be paying off your student loan—which can significantly elevate your DTI.
But that’s okay; Rome wasn’t built in a day. Don’t be discouraged if you currently exceed the recommended ratio. As an education member with the potential to work yourself up the pay grid, all you need is a budget, a carefully crafted financial plan, as well as the commitment to stick to both—and you’ll get that DTI reduced in no time!
Need advice on how to reduce your debt-to-income ratio? We’re just a click and a call away.
No matter where you are in your education career—early on, approaching retirement, already retired—Educators Financial Group offers you the kind of advice that uniquely factors in where you are on the pay grid and what your pension income is in retirement. We like to call that advice ‘educator-specific’.
Call on one of our financial specialists to get your educator-specific, debt-reducing plan into action.
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The information provided is general in nature and is provided with the understanding that it may not be relied upon as, nor considered to be, the rendering of tax, legal, accounting or professional advice. Please ensure to consult your accountant and/or legal advisor for specific advice related to your circumstances. Educators Financial Group will not be held responsible or liable for any losses, costs, damages or expenses incurred by reason of reliance as a result of the aforementioned information. The information presented was obtained from sources that are believed to be reliable. However, Educators Financial Group cannot guarantee their completeness or accuracy.