Do you know your debt-to-income ratio? Is it 120 per cent? 165? 200? And what does that number even mean?
Each quarter, Statistics Canada publishes the average Canadian's debt-to-personal-disposable-income ratio. It's a stat that gets cited often in stories about Canadians' onerous and rising debt loads. ( Click here to read a recent one.)
The latest debt-to-income report from Statscan shows that as of the third quarter of 2011, the average Canadian's debt-to-personal-disposable-income ratio was 153 per cent. That's up from 150.6 per cent in the previous quarter and higher than 148.3 per cent a year ago. Seeing that makes me wonder how I compare.
Turns out, calculating your own ratio is not that difficult. To get your debt-to-personal-income percentage, add up your total debt (including mortgages, loans, credit lines and credit cards) and find out what per cent that is of your annual after-tax income. If you really don't want to do the math, try using this online calculator. Plug in the numbers and voila! Your ratio. For example, if your total debt is $120,000 and your after-tax income is $85,000, your debt-to-income ratio is 141 per cent.
Your next question might be: If my ratio is lower than the national average, does that mean I'm in better financial health than most? Or if I'm higher, am I in trouble?
Not necessarily. Though it's bandied about frequently in the press, the debt-to-income ratio is limited when it comes to measuring one's own financial health. For one thing, it doesn't take equity or assets into account. Also, as Globe and Mail personal finance columnist Rob Carrick noted in this story, it measures things that are not directly comparable, namely your entire debt load vs. one year's net pay (one would hardly be expected to pay off all your debt in one year, right?).
"Another flaw in the debt-to-income ratio is that it lumps together people who have no debt with those who are heavily indebted," wrote Mr. Carrick. "So you get seniors who have paid off their mortgages combined with Vancouver and Toronto residents and their mega-mortgages."
Mr. Carrick pointed out that the debt-to-income ratio is used by economists for a "big picture" view on debt, and unless you are able to compare your ratio with others who are like you – say, young families with mortgage debt or boomers preparing for retirement – measuring yourself against the average number is largely meaningless.
So are there better ways to calculate whether your debt load is financially sound?
Consolidated Credit Counseling Services of Canada has another way to determine your debt-to-income ratio and gauge whether you are in a good position to borrow money or if you are spending too much paying off debt.
Take your total monthly debt payments, including rent or mortgage, minimum credit card, car payments, etc., and divide by your total household monthly income. Multiply by 100. Here is a calculator you can use for that. Because this way of calculating your debt-to-income ratio compares two numbers that are more directly comparable – what's coming in each month versus what's coming out each month – it might give you a better idea of whether your current situation is a healthy one.
According to Consolidated Credit, your debt-to-income ratio should be 36 per cent or less. At 37 to 49 per cent, you should be concerned about your level of debt, and at 50 per cent or more, you should seek out professional assistance to severely reduce your debt.