Also called debt ratio or debt level, the debt ratio is one of the financial indicators most used by bankers. According to Statistics Canada, it reached an all-time high of 181.7% in 2022. In other words, there was $1.81 of debt in the loan market for every dollar of income.
And you, do you know yours? How to calculate it? How to interpret it? Decryption and explanations from our experts.
What is the interest of the debt ratio?
Each time you apply for a loan from the bank, the advisor calculates your debt ratio to find out the state of your finances. It is thanks to this indicator that the bank determines if you are able to take out a loan and repay it.
It also allows you to determine the amount you can repay each month, the maximum capital that can be allocated to you, not to mention the interest and fees to be paid.
Furthermore, it is strongly recommended to do not wait for a loan to calculate your debt ratio. Doing it spontaneously allows you to become aware of the state of your finances, and to assess your possibilities in terms of investment.
This approach also allows you to properly manage your finances, your real estate assets and even your professional career. So don’t wait to be in the red to find out everything about the debt ratio.
The calculation of the debt ratio is simple. The formula to apply is as follows:
Debt ratio: Sum of your gross monthly debt payments/Sum of your monthly income x 100
What are the debts to be taken into account in the calculation of the debt ratio?
To determine the total amount of your debts, add the following elements:
The rent if you are a tenant or the monthly mortgage payment if you repay your mortgage;
The monthly payments of all your credits in repayment: auto credit, personal loan, consumer credit, student loan, etc.
Payments for your credit cards;
Alimony you have to pay.
Note that current bills such as electricity, gas and water are not included in the calculation of the debt ratio.
What income should be taken into account in the calculation?
Each bank defines its own rules regarding the income to be taken into account in the calculation of the debt ratio. But in general, are included:
Net salary before withholding taxes;
Fixed bonuses or benefits, on the 13e month for example;
Commissions, for commercial agents for example;
Assistance received in the context of social benefits.
Basically, include in your income anything that brings money into your pocket.
If you have a variable income, as is often the case for the self-employed, add up your entries over a year and divide the result by two. This will give you your average monthly income.
What is the right debt ratio?
Generally, a good debt ratio is below 30%. In other words, you spend less than a third of your income paying debts. This shows that you manage your finances well. If you apply for a loan from a bank, you have a good chance of getting a positive response.
If your debt ratio is between 31% and 40%, you are still within the tolerable limit. This means that you have no great difficulty repaying your debts at the end of the month.
But be careful, you are at the edge of the red zone! If a large part of your debts is, for example, at variable rates, your debt ratio can rise to more than 40% in the event of a rise in key rates. Which can be catastrophic for your finances!
Basically, your wiggle room is very small and banks may be reluctant to extend additional credit to you.
A debt ratio above 40%
Above 40%, you are already in a situation of over-indebtedness. It is therefore almost certain that the banks will refuse to grant you credit. Indeed, you are already at risk of not being able to meet your current payments. You then need to take quick action to reorganize your finances and get out of the red.
The Licensed Insolvency Trustee, the solution in case of financial difficulties
If your debt ratio is over 40%, consult a licensed insolvency trustee now. This professional is the one licensed in Canada to inform you about the different options available to you in order to get rid of your debts.
It also ensures that your creditors no longer harass you. In addition, they will not be able to initiate recovery proceedings or any other legal proceedings such as the garnishment of your wages against you. In summary, you are better protected when you work with a Licensed Insolvency Trustee.
But do not wait to be in the red to contact him. This professional can also help rearrange your budget to avoid getting into trouble. These tips will also be of great use to you in managing your debts.
In addition, the first consultation is generally free. Do not hesitate!
Also read: How to protect your banking data on your phone?