For every $1 of household disposable income, Canadians have $1.68 in debt. You earn $1, you owe $1.68 – your debt-to-income ratio is 168%. It seems like a fairly startling figure, especially the way some people write about it in news articles. But does this ratio deserve so much attention, merit, and in some cases, concern?
Firstly, it is important to know how the ratio is calculated. The debt portion refers to all outstanding debts owed (ie. Credit card balances, student loans, auto loans, mortgages, etc…). The income part is based on disposable income (income after taxes are deducted). For example, income of $100,000 taxed at 25% leaves disposable income of $75,000. With debts of $100,000 the debt-to-income ratio will be 133% ($100,000 divided by $75,000).
Reasons why this ratio is given too much credit (pun intended):
- It takes into consideration annual income but total debt. For example, using the example above, the consumer would earn $75,000 this year, and next year, and so on. So while they are accumulating income year after year their debt owing ($100,000) would be staying the same (not including debt increases, interest, etc…). The client could payoff $30,000 over two years and now their ratio would be 93%
- It isn’t practical. With income of $100,000 a fairly large mortgage can be supported. If total debts with a mortgage are now $500,000 the debt-to-income ratio would be 667%. This figure seems extremely high if going based on the debt-to-income ratio alone
- It does not take into consideration other assets. Ie. Two people each with $75,000 disposable income and $500,000 in debts. If one of those people have $1million in savings/equity while the other only has $100,000 both would have the same debt-to-income ratio as assets are not considered. While one is clearly better off, the ratio says they are financially the same
This ratio has its use as a general, broad, figure for Canadian consumers but there are far more valuable ratios to consider. For example, the monthly income-to-monthly debt ratio compares how much you earn per month compared to how much you are paying out to debts. A simple cash flow analysis that assists with practical uses like budget creations.
So before you read too much into the “high” debt-to-income ratio, take some time to understand what it is based on and how it truly does, or doesn’t, represent your financial standing.
In other news, you may have heard about the Equifax security breach in the United States. While the majority of the breach occurred with American client data, Equifax did mention that some Canadians may have had “limited personal information” breached.
They have set up a website -- www.equifaxsecurity2017.com -- for consumers to check if their personal information has been compromised. Otherwise consumers can call in to 866-447-7559 for more information. If you would like to discuss any of these topics with me, feel free to contact me whenever.
Sincerely,
Jonathan Buffone