Along with your credit history, the Debt Service Ratio is a strong decisive factor of your creditworthiness and how much you can successfully borrow

Applying a home loan (or any loan) is not always as easy as you think it is, in fact, it can be a very long and tedious process. When you submit a housing loan application, your Debt Service Ratio (DSR) is a major consideration. The Association of Banks Malaysia also attributes DSR as one of the main reasons for rejecting loan applications.

Photo by Steve Johnson from Pexels.

Debt Service Ratio is essentially a measurement of one’s ability to repay loan and credit commitments. The basic formula to calculate DSR is:

Total Monthly Commitments ÷ Total Monthly Income × 100% = Debt Service Ratio

Monthly income is best derived from steady and documented earnings via salary slips, EPF statements and income tax receipts. Inconsistent freelance work, rental income and/or being self-employed may not convince the banks much. Monthly commitments include all credit card payments, set instalments for loans, insurance and other borrowings.

Banks will have their respective calculation method for income and commitment recognition, additional risk assessment calculations and different levels of acceptable DSRs. It is not uncommon to have up to 20% difference when different banks calculate the DSR for the same person. Generally, the accepted percentage is to have your no more than 60%. A high DSR is a red flag from the bank’s point of view as it means your existing borrowings and repayment is high compared to your income.

Do remember that everyone’s DSR will vary, according to individuals’ profile, commitments, and their respective levels of net income. So, don’t compare yourself to others.

Photo by Dietmar Becker on Unsplash.

Let’s take a look at an example, Adam’s DSR:

Total Monthly Income: RM7,000
- Gross Salary (RM7,000)

Total Monthly Commitments: RM3,650
- Personal Loan (RM1,100),
- Insurance (RM500)
- Credit card (RM1,200)
- Car loan (RM850)

Adam’s basic DSR would be calculated as: RM3,650 ÷ RM7,000 × 100% = 52.14%

With an income of RM7,000 monthly and a monthly commitment of RM3,650, Adam has a DSR of 52.14%. Depending on the bank’s more accurate calculation, this percentage could be challenging to get approved for a home loan. Our best advice is to keep your basic DSR to around 30% to 40% before applying for a home loan.

What can you do to improve your DSR?

Reduce your debt! If you have debt from other loans or unpaid cards, it is best you clear it up. You can also consolidate multiple repayments into one loan too, thereby simplifying your repayments into one; it saves on interest too.

Minimize! Try to reduce the credit cards in your name as much as possible. This is especially so if you are one who impulsively spends with a credit card.

Or if you're the kind who keeps a mini wallet just for your credit cards. Photo by Oliur on Unsplash.

Always pay on time! Whenever your bills or credit card statements come, always pay it off 100%. What may seem like an unpaid small amount can stack up with the following months, resulting in a large debt monster.

Read 5 Tips for better debt management here.

Other factors to assess your creditworthiness?

Central Credit Reference Information System (CCRIS) and CTOS reports can help the bank to assess your creditworthiness.

CCRIS report shows your existing outstanding credit and application for credit that you made in the past 12 months, whether it was approved, pending, or rejected by the bank. CCRIS also shows the capacity of borrowing that you took from the bank, such as the sole proprietor, partnership, joint application or acting as guarantor.

CTOS report contains your full credit history, payment behaviour, your CTOS score, directorship as well as business interests, litigation, and bankruptcy. It is pretty much your credit health and score at a glance.

All being said, it is important to have some good debt to help build your credit score and also to have an excellent debt service ratio. This will make it easier for you when you are applying for financing in the future.

The original version of this article was published by CompareHero.my, a site dedicated to increasing financial literacy and helping you save time and money by comparing credit cards and personal loans in Malaysia.

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