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You’ve found the perfect sofa for your living room. You need a sofa, right? A person has to sit somewhere. But can you afford the new sofa? For many people, ‘afford’ means having room on the credit card. Unfortunately, there is a big difference between having the means to pay for something and being able to truly afford it.
In today’s consumerist society, living within one’s means can seem like a quaint, old-fashioned notion, like paying cash for everything. However, knowing your financial limits and living within them remains the primary secret to attaining wealth and financial security.
You can probably justify any purchase to yourself – if you really want it. By denying the limits of your income and expenses however, you can quickly find yourself in serious financial trouble, on the basis of just a few too many purchases that you erroneously thought you could afford.
Your TDS ratio
There is a simple way to calculate what you can afford - or how much you have to spend – on a monthly basis. It’s called the Total Debt Service ratio or TDS, as those in the financial-know like to say.
The rule of thumb for TDS is that all your monthly debt payments should be less than 40 percent of your gross monthly income. This 40 percent should include your housing costs (rent or mortgage payments), your car payments (leases or loans) and all the other credit payments you make each month - including credit cards (yes, those too!), lines of credit, student loans and other personal loans.
If you can keep your debt payments within 40 percent of your income, then the remaining 60 percent can be allotted to ‘discretionary’ spending – such as groceries, clothing, movies, transportation costs and your shopping habit. (Factor in some savings too!)
Here is how to calculate your TDS ratio in three easy steps, so you can see how you’re currently faring; either do it personally or with your spouse to determine a household figure.
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Step one: your salary income
Check your pay statements to determine your gross monthly salary. This means what you earn in total each month, before deductions such as taxes and CPP are taken off. If you are calculating your household TDS, rather than just your own, then add your hubby’s gross monthly salary as well.
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Step two: add any other income
Now add any income that you receive on a regular, monthly basis. Maybe it’s child support payments, investment income or cash from a part-time job. (Maybe trust fund payments or royalties from the songs you wrote for Beyoncé? Don’t we all wish!)
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Step three: multiply by 0.40
Take your total income (step 1 + step 2) and multiply the total by 0.40. Voila! The result is your total debt service ratio – the maximum amount you can afford to spend on your monthly debts and expenses.
The upper limit
Suppose, for example, your TDS calculates to $1800. If you find you are actually spending less on your housing, loan payments and expenses - say $1500 a month - then congratulations frugal girl! Technically, you are living within your means. Just remember, that TDS calculation represents your upper limit.
On the other hand, if you are actually spending more than your TDS figure on monthly debt obligations, then your ability to afford the rest of your life probably feels severely constrained. Try to re-negotiate loan payments and make it a priority to pay down those debts and get your TDS back in line.
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