How do I calculate my Debt Service Ratio?

Calculate debt service ratio

What is a ‘debt service ratio’?

If you have ever applied for a car, home or personal loan, you will probably have heard the phrase ‘debt service ratio’ from the bank’s loan officers whilst they explain to you how the loan works.

The debt service ratio is one of the key factors that a bank will evaluate when performing their due diligence during a loan approval process.

It is a calculation used by banks to see how much more money you can borrow before you are unable to service the monthly installments of the loan. This is calculated by taking any of your outstanding loan and/or credit facilities, and comparing it against your total income. In layman terms, a debt service ratio is used to check whether you can repay a loan.

Aside from that, there are other factors such as CCRIS and CTOS reports that help the banks assess your credit-worthiness (or credit health). This helps them ensure that they do not issue out a bad loan. However, in this article, we will be focusing on the debt service ratio and how it affects your chances of getting a loan.

Why is a debt service ratio important?

Your debt service ratio matters a lot because it influences the bank’s decision to lend you money or not. In 2015, Bank Negara Malaysia reported that “80% of new loans were issued out to borrowers with aggregate debt service ratio of below 60%.”

This shows that banks are actively working to limit credit risk exposure when issuing out loans, as well as ensuring that borrowers are able to sustain their debt capacity. They are pretty much protecting their interests and yours; ensuring you don’t borrow above your means, causing you to be unable to repay and in extension, costing the bank money.

How do I calculate my debt service ratio?

You have to first gather all the relevant financial information about your gross income and financial commitments. Prepare documents such as your monthly salary slips, EPF statements, hire-purchase agreements, personal loans, mortgages, and any other relevant financial documents. You can refer to this list as a general guide:

  • Monthly commitments
  • Monthly income
  • Payslips
  • Property rental yields
  • Personal loan instalment
  • Car loan instalment
  • Housing loan instalment
  • PRS Withdrawals (for retirees)
  • Credit card statements

With all the information, you can then use this formula to calculate your debt service ratio:

Total Monthly Commitments / Total Monthly Income X 100% = Debt Service Ratio

For example:

Rosie has a net monthly income of RM6,000 and is currently servicing two personal loans and one housing loan that totals up to RM4,000 every month. If she is to calculate her debt service ratio, it would be:

RM4,000 / RM6,000 x 100% = 66.67%

Even though Rosie has a guarantor for the housing loan, this shows that she has a debt service ratio of 66.67%, which is slightly below 70%. While the general rule of thumb is to ensure that your monthly commitments do not exceed 1/3 of your income, different banks can have different requirements based on the debt service ratio for approving the loan application.

However, based on Rosie’s current debt service ratio, she may find it extremely difficult to get any future loan applications approved, as an additional financial commitment will push her debt service ratio over 70%.

How can I improve my debt service ratio?

If many of your loan applications have been rejected recently, it could be time for you to kick start a financial plan to improve your debt service ratio. One of the best ways for you to start improving your debt service ratio is to slowly clear off your debts one by one via the snowball method.

You may choose to consolidate multiple repayments into one loan too, thereby simplifying your repayments into one. This will save on interest, and stretching out the monthly repayments will reduce the impact on their debt service ratio.

Try to minimize the number of loans and/or credit cards in your name as much as possible, to ensure that your monthly income isn’t strongly affected by many repayments.

Whether you choose to pay them off one by one or consolidate them simultaneously, this will benefit you in the long-term by improving your chances of getting your loan approved in the future.