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You're not alone if you're mystified by the headline number being used to repeatedly bludgeon Canadians about high debt levels.

The widely quoted debt-to-income ratio is vague enough to have prompted several readers of this column to ask what it means. Economist Benjamin Tal understands their bewilderment.

"Let me tell you that this is one of my least favourite economic indicators," said Mr. Tal, a specialist on household credit at CIBC World Markets.

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The ratio of household debt to income recently hit a record 148.1 per cent, which you'd have to be dead or comatose not to know because the number is so often mentioned by experts and the media. It's a handy number to sum up our very real debt problem collectively, and it's also an eye-catcher because it seems to suggest a level of greediness in our borrowing.

In truth, the debt-to-income ratio means little or nothing unless you know how to put it in context.

One problem with the debt-to-income ratio is that it measures two things that are not directly comparable - your annual disposable (after-tax) income and your total stock of debt, including mortgages, credit lines, credit cards and loans. Don't worry, no one expects you to be able to cover all your debts with one year's salary.

Another flaw in the debt-to-income ratio is that it lumps together people who have no debt with those who are heavily indebted. So you get seniors who have paid off their mortgages combined with Vancouver and Toronto residents and their mega-mortgages.

Aware of its limitations, economists consult the debt-to-income ratio for a big-picture view on debt. They also use measures such as the percentage of after-tax income that goes to interest payments, which actually looks pretty good right now. Debt interest payments accounted for 7.2 per cent of disposable income in the third quarter of last year, compared to 8.3 per cent in late 2007.

Where You Fit In

But the debt-to-income ratio gets mentioned most often, and it's starting to soak into the public consciousness.

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"So much has been written in the media during the latter part of [2010]about the fact that household debt is at an all-time high," one reader of this column noted in a recent e-mail. "When I read about this I immediately wondered where my own household fits into the equation."

Stop wondering, Mr. Tal says. Your own debt-to-income ratio can only be assessed properly with a comparison to people who are like you. Say, thirty-somethings with giant mortgages and sundry other debts, or fifty-somethings, who should be winding down their mortgages and other debts so they can enter retirement owing nothing.

"You cannot apply the debt-to-income ratio to yourself - that's a big mistake," Mr. Tal said. "Don't try to see if you're above average or below average because it's meaningless."

Proper use of the debt-to-income ratio starts with ignoring the actual level of the moment. "I never focus on the level - it could be 500, it doesn't make any different to me," Mr. Tal said.

What To Focus On

What he does focus on is, first, the rate at which the ratio is rising. You won't come away less worried about debt levels after you check out the growth numbers. Mr. Tal said that before the financial crisis, the debt-to-income ratio was less than 130 per cent.

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The big increase since then is notable in its own right, but it's staggering when you realize that much of the growth came while the economy was in recession. Mr. Tal calls it the first recession where debt levels actually grew.

Mr. Tal also focuses on how increases in the debt-to-income ratio compare to growth in income. He said incomes were rising at about 2 per cent not too long ago, while the debt-to-income ratio surged by 12 per cent. That's a scary mismatch, but it should be noted that the situation has improved a fair bit according to the most recent numbers. They show income rising in the 3- to 4-per-cent range, while the debt-to-income ratio gained about 5 to 6 per cent.

The debt-to-income ratio in the United States has been falling lately, and it's now a bit below us at around 147.2 per cent. Mr. Tal believes it would take a severe economic shock for the debt-to-income ratio in Canada to drop. Barring that, he sees the ratio rising steadily, but not necessarily alarmingly, in the years ahead.

"Will we see a debt-to-income ratio 20 years from now over 200? Absolutely. Will it be a bad thing? Not if it rises slowly."



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