Published on November 25th, 2009 | by Canadian Credit Expert1
TDSR and Car Loans
TDSR and Car Loans
Many Canadian consumers fill out a car loan application already knowing the result. Some anticipate rejection or at least a little extra effort before the application is approved. Others predict instant approval. Consumers expecting rejection almost always have bad credit. In addition to self aware bad credit consumers there are also many consumers in Canada that are in ‘bad credit denial’.
A bad credit customer in denial will often change their tune after receiving the bad news and ultimately admit they have credit problems. That is a very common scenario. A not so common scenario is the rejected car application for a consumer with good credit.
There are occasions where someone with strong credit can walk into a car dealership, apply for a car loan and still be denied. Although it surprises both the consumer and the car dealer, it is actually quite common. This often shocking result is caused by a lack of affordability and sometimes referred to as the Debt Service Decline.
It’s actually quite common in Canada for a loan applicant with a near perfect credit history to find their auto loan declined. If you have a high beacon score or fico score (credit score available on your Canadian credit report) but can’t get approved for a loan, you affordability is likely the issue.
Borrowing money isn’t just about credit history, it’s also about affordability. A perfect credit history often represents strong character, financial responsibility and commitment to follow through on an agreement. There is however one thing that good credit history doesn’t guarantee and that is affordability.
While having a positive payment history can showcase your ability to make loan payments on time, it says nothing about your capacity to pay. When making a credit decision banks do not rely solely on credit bureaus and credit scores, they also make use of your personal and employment details. After all, the best credit in the world means nothing if the applicant doesn’t have enough income to support the loan.
When reviewing a car loan application most lenders will assess the applicant on their credit history first. After assessing their credit, the bank will then add up the applicants debts and compare them to their monthly income. Every consumer should know this:
Approvals are based on credit history AND affordability.
Total Debt Service Ratio
The Total Debt Service Ratio (or TDSR) is a financial ratio that indicates your personal debt load and your loan affordability. The ratio, presented as a percentage, tells you or the bank how much of your monthly income is required to cover your monthly debt and expenses.
The formula for TDSR is simple. Divide the total of your monthly bills and expenses by your monthly gross income. The resulting number is your Total Debt Service Ratio.
Most banks and lenders consider a 40 – 50% Total Debt Service Ratio to be a considerable risk factor. In Canada many banks, including special finance and subprime auto lenders will not lend at a debt service ratio above 45% and few will allow 50%.
Before you apply for a car loan, it’s wise to do a self review of your debt load. If your monthly debt is greater than 30% of your monthly income, you should consider how important a car loan is to you.
If your debt service ratio is approaching 50% of your household income, then it’s possible that adding a car loan into the mix will put you over the 50% threshold and prevent you from qualifying for a car loan.
Co Signor or Co Applicant
Depending on the bank or finance companies guidelines, a co-applicant or co-signor might be enough to get your auto loan approved. If you have a spouse or common law with a source of income, then the addition of their income to your application could make a difference.
Of course debt service rules apply to spouses as well as applicants, so be aware that adding a spouse to your credit application could in fact hurt your debt service ratio.
Read more about co-signors and co-applicants in our Your First Car Loan article.
Pay Down Your Debt
Debt service problems often result from consumers having high credit card balances or maxed out lines of credit. If you’re carrying a lot of debt on your credit cards and you can afford to pay them down, do it.
Not only is paying off your credit card debt a smart financial move, it’s also a way to lower your debt service ratio and hopefully get you approved on a car loan.
Non Prime Car Loan
Sometimes a prime bank will hold back an otherwise routine approval because of high debt service. Depending on how high your debt service ratio is, it might be possible to apply at a non prime bank or sub prime auto lender and get approved for the same car loan.
Non prime auto lenders usually have higher interest rates but most of the time its justified. Although you might have good credit, it’s important to remember that a regular prime bank considers your high debt service ratio to be a risk.
The sub prime car lender is willing to take the risk but they will charge you for it.
Honest Credit Application
Remember to be honest on your credit application, many banks will ask you to prove your income and monthly rent or mortgage. Not only should you consider the lender when being honest, you should also consider what could happen to you if you lie on your credit application and it leads to credit problems on a loan you can’t truly afford.
If you’re stuck with a car loan you can’t afford, then your loan could be repossessed, your credit could be seriously damaged or you might even find yourself in a situation where you have no choice but to file for bankruptcy or consumer proposal.
Remember, in Canada there are plenty of ways to get approved with any bad credit. Good luck.