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Total Debt Service: Everything You Need To Know

Dan Rafter4-minute read

December 29, 2020

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You probably already know that your three-digit FICO® credit score is a key number when applying for a mortgage. If that score is too low, lenders will hesitate to approve you for a mortgage. But did you know that your total debt service is another key financial factor that will determine whether you qualify for a mortgage?

What Is Total Debt Service?

Total debt service measures the percentage of your gross annual income – your yearly income before taxes are taken out – that you need to make your loan payments and cover your other yearly debts. It’s similar to your debt-to-income ratio in that it analyzes how much of your income is consumed each month, or year, by your debt obligations. If you have a higher amount of debt, you’ll have to spend a greater percentage of your gross annual income on paying it off.

If you want to borrow money, it’s best to have a lower total debt service: This will make lenders feel more confident that you can afford to pay your new monthly loan payment.

Your total debt service is amount of money you need to fully repay your debt during a certain period of time. You can calculate your total debt service for a month, a year or any other period. Your total debt service should be enough to cover both the principal and interest payments of your loans and other debt obligations.

How Does Total Debt Service Work With A Mortgage?

Lenders are cautious when approving mortgage loans. They want to make sure that borrowers can afford to make their monthly payments on time. Debt service calculations help with this task. If borrowers’ debts are already consuming too much of their gross monthly income, lenders will be more hesitant about approving them for a mortgage loan.

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What Is The Debt-Service Coverage Ratio (DSCR)?

The debt-service coverage ratio measures how much of your income particular debts consume. Mortgage lenders, for instance, want to know how much of your income would go toward paying off your housing costs.

Lenders consider a host of costs to be housing expenses. This includes your estimated new mortgage payment, including principal and interest; property taxes; homeowners' insurance; and HOA fees if you live in a condo.

Lenders will consider you more of a risk to miss your mortgage payments if you’re spending too much of your income on housing costs. If you’re spending 50% of your income on housing, you're far more of a risk to miss payments than if you’re spending just 20% of your income on these costs.

If a new mortgage payment would result in you spending too much of your income on housing costs, lenders will be more likely to reject your mortgage loan application. If lenders do approve you for a loan and too much of your income is being used on housing costs, they’ll usually charge you a higher interest rate to mitigate some of the risk they’re taking on by lending to you.

How To Calculate The Debt Service Coverage Ratio

Calculating your debt service coverage ratio is relatively simple. You need to know just two figures:

  • Net operating income: Net operating income is your total amount of income if you are running a business. If you are applying for a personal loan, you’d probably refer to this as your gross annual income, your annual income before taxes are taken out. This would include your monthly salary, any freelance money you earn, rents you collect, legal judgments you’ve been awarded, royalties you collect and any other form of income you make. If you are interested in buying a home for real estate investing, earning money by buying, holding and then selling homes for a profit, your net operating income is a key factor in your ability to buy additional properties.
  • Total debt service: This is just another word for the total amount of debt you pay each year. This would include your estimated new mortgage payment, property taxes, credit card bills, auto loans, student loans and any other payment you make each month. Businesses, of course, take on a wider range of debts each year. Their total debt service would include the money they pay out in salaries, business taxes and other expenses involved in running a business.

Your debt service coverage ratio is calculated by diving your net operating income by your total debt service.

DSCR Formula

Say you want to buy a home costing $225,000. If you make a down payment of $25,000, you are left with a mortgage of $200,000. If you take out a 30-year, fixed-rate loan with an interest rate of 3.25%, you'd have a monthly payment, not including property taxes or homeowners insurance, of about $1,345.

Say the property taxes on that home are estimated to be $6,000 a year. That would add $500 to your monthly housing debt. And if your homeowners insurance is $2,400 a year, that'd add another $200 to your monthly housing debt, making for a total of $2,045 or $24,540 a year.

Say your other debts include a $300 monthly car payment and a $300 monthly student loan payment. Those two debts would add $7,200 to your yearly debt, making your total yearly debt $31,740.

If your total annual income is $80,000, your debt-service coverage ratio would be just under 40%. Most lenders would be comfortable approving you for this mortgage because your total debt would be less than 43% of your gross income. And your total housing debt – $24,540 a year – would be just over 30% of your annual income.

The Bottom Line

Lenders only want to pass out mortgage dollars to borrowers who can afford their monthly housing payments. That’s where debt service comes in: If you have too much debt for your gross annual income, you might struggle to convince a lender to approve you for a mortgage loan. If you want to learn more about how debt, income and credit scores impact your chances for a mortgage, read more mortgage tips at the Rocket Mortgage® Learning Center.

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Dan Rafter

Dan Rafter has been writing about personal finance for more than 15 years. He's written for publications ranging from the Chicago Tribune and Washington Post to Wise Bread, QuickenLoans.com and RocketHQ.com.