How Debt-Service Ratio Affects Your Loans
Ever wondered how exactly banks calculate a person’s eligibility for a housing loan? Some forms are filled in, keyboards are pounded on, calculations are penciled in and suddenly your loan application is either accepted or rejected! How does this happen?
If you are as baffled as many people are about the loan eligibility determination methods used by banks, then you should know that one of the main parameters used by banks to calculate a person’s loan eligibility after taking into account all the other debt they have is the Debt-Service Ratio.
What is a Debt-Service Ratio?
The Debt-Service Ratio, acronym DSR, determines your ability to repay, in instalments, the amount you borrow from the bank by compiling your loan and credit commitments and comparing it to your income level.
The actual calculations and acceptable percentage is up to the discretion of the bank, but a good rule of thumb is 60% of your nett income.
How is a Debt-Service Ratio Calculated?
Your Debt-Service Ratio is calculated by taking into account all of your existing commitments such as existing debt (CCRIS is a major contributor here) plus the monthly instalments required of you to pay off your housing loan (if approved) divided by your net income (minus Socso, EPF, etc.) and multiplied by 100 to get a percentage.
The acceptable Debt-Service Ratio for each bank will vary and so will the rationale behind it; but generally a hopeful housing loan applicant can expect 70% to be the highest acceptable Debt-Service Ratio percentage, with 60% being the aforementioned rule of thumb.
To put this into perspective, let’s say that you make RM10,000.00 a month and have an outstanding debt of RM4000.00. If the monthly instalments for the housing loan are set at RM1500.00, then you would take RM5500.00 divided by RM10,000.00 which will give you 0.55 and 55% after multiplying it by 100. This means that your Debt-Service Ratio is 55%, which translates into a pretty good chance of acceptance by your bank.
What to do if Your Application is Rejected
If your application has been rejected, it’s an obvious sign that the numbers in your Debt-Service Ratio need to be adjusted. This means that you need to either increase your monthly income or reduce your existing debt. Both of these options are not feasible short-term goals. (Or you can simply try another bank, since each bank has its own algorithms and determining factors.)
Another thing that can be done, if possible, is that the bank will decrease the amount due as monthly instalments on the housing loan and prolong the loan repayment term. Once this is done, they will recalculate your Debt-Service Ratio to see if you fall within the acceptable limit the second time around. Talk to your bank – you never know what leeway they may allow you!
Acceptable Limit Does Not Equate Affordability
If your Debt-Service Ratio is calculated and the figure is below 60%, enabling your application to be accepted by the bank, it does not necessarily mean that buying a house at the moment or at a certain rate is truly something you can afford.
The Debt-Service Ratio calculation does not take into exact consideration the other things you need to fork out money for like food, utilities, transportation and so much more that has become essential nowadays.
While the Debt-Service Ratio is a pretty easy method of calculating whether a person can afford to repay a housing loan given by the bank, it does not mean that it is the most reliable.
Be responsible and do your own calculations based on your monthly budget to determine whether you can really afford to fork out the monthly instalments required of you if you take that housing loan.