What is Gross Debt Service Ratio ?

926 reads · Last updated: December 5, 2024

The gross debt service (GDS) ratio is a debt service measure that financial lenders use to assess the proportion of housing debt that a borrower is paying in comparison to their income. The gross debt service ratio is one of several metrics used to qualify borrowers for a mortgage loan and determine the amount of principal offered.The gross debt service ratio may also be referred to as the housing expense ratio or the front-end ratio. Generally, borrowers should strive for a gross debt service ratio of 28% or less.

Definition

The Total Debt Service Ratio (GDS) is a debt repayment capacity indicator used by financial lenders to assess the proportion of a borrower's income that is used to pay housing debt. It is one of several indicators used to evaluate a borrower's mortgage qualification and determine the amount of principal offered. The Total Debt Service Ratio is also known as the housing expense ratio or front-end ratio. Generally, borrowers should aim to keep their Total Debt Service Ratio at 28% or below.

Origin

The concept of the Total Debt Service Ratio originated in the mid-20th century as the housing loan market expanded, and financial institutions needed a standardized method to assess borrowers' repayment capacity. This ratio helps banks and lending institutions evaluate risk when offering loans, ensuring borrowers can repay loans on time.

Categories and Features

The Total Debt Service Ratio is primarily used to assess the repayment capacity for individual housing loans. Its features include simplicity and ease of understanding, calculated by dividing a borrower's housing-related expenses (such as mortgage, property taxes, insurance) by their total income. The advantage of this ratio is its intuitiveness, allowing for a quick assessment of a borrower's financial health. However, its drawback is that it does not consider other types of debt, such as credit card debt or car loans.

Case Studies

Case Study 1: During the 2008 financial crisis, many borrowers had a Total Debt Service Ratio exceeding 28%, leading to their inability to repay loans on time, ultimately resulting in widespread mortgage defaults. Case Study 2: A bank, when reviewing a loan applicant, found their Total Debt Service Ratio to be 25%, thus approving their loan application as the ratio indicated the applicant's ability to repay the loan on time.

Common Issues

Common issues include how borrowers can lower their Total Debt Service Ratio. It is usually advised to increase income or reduce housing-related expenses. Additionally, a misconception is that this ratio covers all types of debt, whereas it primarily focuses on housing-related expenses.

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