Your Debt-To-Income Ratio

Each quarter, Statistics Canada publishes the average Canadian's debt-to-personal disposable-income ratio. It's a statistic that gets mentioned often in stories about Canadians' onerous and rising debt loads.  As a matter of fact Canada’s household debt-to-income ratio has risen from below 100 per cent in the mid-1990s to 151 per cent today.

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. 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.

Though it's chirped about frequently in the press, the debt-to-income ratio is rather limited when it comes to measuring one's own financial health. For one thing, it doesn't take equity or assets into account.  Furthermore, 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?).

To keep things in perspective recognize 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 (ie. young families with mortgage debt or boomers preparing for retirement)  measuring yourself against the average number is largely meaningless.

A better way to calculate whether your debt load is financially sound is by taking 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.  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.  This calculation is also referred to as a PDSR (Personal Debt Service Ratio) and is typically utilized by financial institutions as part of the credit granting process.

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.