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Living Within Your Means
What is living within your means?
When youâ€™re thinking of buying a house or taking on another loan, itâ€™s important to take a hard look at what you can afford. You may feel like you can afford an extra $600 a month, but when you start looking at what you can get for $800 a month, well, maybe if you cut back on going out for dinner now and then â€¦ but how can you be sure? Would you still be living within your means?
Financial advisors have invented two important ratios for taking the guesswork out of affordability: GDS (Gross Debt Service Ratio) and TDS (Total Debt Service Ratio). Each involves just a few steps â€“ made easy with this calculator.
When it comes to housing, the rule of thumb is that your monthly housing costs should not be more than 32 percent of your gross monthly income. Financial advisors apply a calculation known as the Gross Debt Service Ratio, or GDS. Keep in mind, 32 percent GDS is the maximum amount you can afford to spend on monthly housing costs, including mortgage payments or rent, property taxes, and utility bills. If you are above this, you need to reconsider your housing costs and look for ways to save (and/or move).
What is TDS?
To make sure you are fully living within your means, itâ€™s important to look at your entire monthly debt load: your Total Debt Service Ratio, or TDS. The rule of thumb here is that all of your monthly debt payments (including housing) should not take up more than 40 percent of your gross monthly income. (For you alert cookies out there, this means that you have a mere 8 percent to work with, over and above your housing costs or GDS). Keep in mind, 40 percent is the maximum amount you can afford to spend on your housing costs, your car payments and all the other credit payments you make each month, including any additional mortgages, leases, credit cards, lines of credit, student loans, and other personal loans. If you are above this, you are indeed living beyond your means.
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