Examining Debt-to-Income Ratio
What is the debt to credit ratio?
Canadian national news has made a point of offering intense scrutiny on the rising levels of debt across the country. An oft-cited figure is that of the debt-to-income ratio. This is defined as the ratio of the accumulated stock of household debt in Canada in the final quarter of 2014, relative to annual disposable household income. For practical purposes, it is a measure of the expansion or contraction of household borrowing. This ratio is at a record-high in Canada, approaching 163.3 per cent according to recent statistics from the Globe and Mail.
DTI is one component of a larger picture
However, this ratio alone does not tell the whole story when it comes to an assessment of the paths Canadians should choose in their approach to financial planning. It is but one component of a larger picture upon which these decisions should be based.
Firstly, consider that the ratio measures one’s entire debt load compared to one year’s net pay. One might not be expected to pay off their entire existing debt in a single year – student loan holders, for example. There is also the consideration that, at a national level, debt-to-income ratio aggregates those Canadians with high debt loads and those with almost no debt. Additionally, borrowers at many different financial and demographic stages are combined for the purposes of obtaining this metric, making it difficult to assess exactly where a particular individual might compare to the average. A fascinating Statistics Canada study by R.K. Chawla and S. Uppal has examined the relationship between household debt and numerous factors including income level and financial literacy.
How do you calculate debt to income ratio?
To obtain a basic personalized assessment of your debt-to-income, you can 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.
According to industry reports, your debt-to-income ratio should ideally 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 (such as that offered by UrLoan and our sister organization, Progressa) to end the cycle of expensive short-term borrowing and significantly reduce your debt.