What is the debt ratio?

What is the debt ratio?

The debt ratio indicates what proportion of your assets (house, car, investments, etc.) and income depends on your debts. It is also referred to as the “debt ratio” or “debt level.” This ratio gives a clear idea of the place your debts occupy in your financial life.

• A high ratio means that you owe a lot of money in relation to what you earn or own
• A low ratio means that you have less debt and a more stable financial situation

Banks use this ratio every time you apply for a loan. They analyze it to check whether you are, in theory, able to repay what you borrow. This is not a judgment on you. It is simply a tool to assess your financial situation.

Understanding this ratio also allows you to better assess your situation, to know if your debts are still manageable… or if they are taking up too much space. It is a simple way to spot a problem before it becomes too much to bear.

How do I calculate my debt ratio?

The calculation is simple:
Debt ratio = (Total monthly debts ÷ gross monthly income) × 100

For example, if your monthly debts total $1,800 and your gross income is $4,000, your debt ratio is 45%.

$1,800 ÷ $4,000 x 100 = 45%

What debts should be included in the debt ratio calculation?

It is important to include all your debts, even those considered “good debts” such as a mortgage or car loan.

• mortgage
• car loan
• credit card
• line of credit
• store financing (appliances, furniture, etc.)
• personal loans

A good rule of thumb is that if you have to pay an amount each month, it should be included in the calculation.

This step is important because some people underestimate their debts by forgetting small payments, such as a financed phone or a purchase paid for in installments. However, it is precisely these payments that, when added together, can increase the ratio without you realizing it.

Why is the debt ratio important?

A ratio that is too high can put you in a vulnerable position by leading to:

• Difficulties obtaining a loan or refinancing
  Banks may decide that you already have too much debt and refuse to give you a new loan, increase your interest rate, or require a co-borrower.
• More stress in your daily life
  Debt is a source of worry. It can cause anxiety, insomnia, and constant concern about the future.
• Risk of over-indebtedness and default
  When debt takes up too much of your life, a simple unexpected event can derail everything: job loss, rate increases, car repairs, etc. This can lead to late payments and, sometimes, default.

How can you improve your debt ratio?

Here are three simple steps that can help you achieve a better debt ratio:

• Reduce your high-interest debt
  Credit cards and lines of credit are very expensive each month. Paying off these debts first will help your ratio decrease more quickly. Even a small additional amount makes a difference.
• Avoid taking on new debt
  Before buying on credit, ask yourself, “Is this really necessary right now?” Postpone certain purchases or save in advance to avoid straining your already tight budget.
• Increase your income
  Every little bit helps: overtime, small contracts, selling items you no longer use. A slightly higher income automatically improves your ratio.

If you feel that your debts are taking over your life, there are solutions. Our trustees can guide you, without judgment, and help you regain control of your financial situation.