Sep 16, 2016
Personal Investor: Is your household debt out of control?
By Dale Jackson
Let’s be clear about why banks and economists are so concerned about the latest record-high Canadian household debt numbers. The nearly 170 per cent debt-to-disposable-income ratio reveals less about how much we owe and more about our ability to make regular payments.
How much we owe is our problem; whether or not we can pay it back is the bank’s problem. Here are some questions to ask yourself, in order to figure out whether your household debt is out of control:
So, what’s it to me if the average Canadian household owes $1.70 for every dollar it takes in?
The best way to begin answering that question is to calculate your own debt-to-income ratio. Statistics Canada compiles total debt – that includes your mortgage, car loan, lines of credit, credit card debt – anything you owe.
Those debt liabilities are then divided by your total annual household earnings after taxes (total income) and multiplied by 100.
Ok, I did the math. What does it mean for me?
Well, it depends on where you are in life. Suppose your debt-to-income ratio is 300 per cent and you’re young, with a big new mortgage, student debt and a modest, entry-level paycheque. All that debt is probably amortized over a long period of time and can be adjusted to avoid over-straining your household budget. Banks love that.
You may also be a disciplined saver, able to devote a large portion of your income to debt by making short-term sacrifices for a better future.
Inversely, suppose your debt-to-income ratio is 60 per cent. You make good money, you’re nearing retirement, you own little in terms of assets, and all your debt is a high-interest credit card balance. Your present could be looking brighter than your future because that debt is growing fast and you may not have enough assets to support you in retirement.
Is there a better way to gauge my debt situation?
Yes. Try the debt-to-asset ratio – better known as “what you own versus what you owe.” In other words, how much money you would have left if you sold everything and paid all your debts.
The debt calculation is done exactly the same: Tally up your mortgage, car loan, lines of credit, credit card debt – anything you owe.
Then, divide that debt by your total assets, which should include the appraised value of your home, savings and investments including registered retirement savings plans (RRSP) and tax free savings accounts (TFSA), and any other property that will grow or retain its value.
Multiply by 100.
The name of the game is to have a low debt-to-asset ratio. If you owe $500,000 and you have $100,000 in assets it’s 500 per cent. Inversely, if you owe $100,000 and you have $500,000 in assets your debt-to-asset ratio is 20 per cent.
Once again, whether the result is good or bad depends on where you are in life. In both cases the goal is zero, but if you plan to retire with no debt and no assets, you may be in trouble.
If you’re young, the number may be discouraging but it sets a benchmark for lowering debt and increasing assets over the years.
Time is on your side.
Dale Jackson is BNN's Personal Investor. Follow him on Twitter @DaleJacksonPI
