What is the right debt ratio?

What is the right debt ratio?

Whether it‘s a mortgage or a car loan (which also happens to be a form of debt), debt doesn’t have to be a bad thing for your bank account. On the other hand, these can be problematic if they become more substantial than your financial capacity to repay them.

Here are some explanations that will allow you to see more clearly to always maintain the right debt ratio and thus avoid finding yourself in a delicate financial situation.

I’m in debt, good or bad thing?

Your loans and/or mortgages are part of your assets. If your loan is used, for example, to acquire an income property or even a second home, it’s a safe bet that this acquisition will increase in value over the next few years.

Your debts can therefore bring you money! In some cases, the money you have invested wisely will earn you more than it costs you in interest charges. We can then say, without a doubt, that this is a “good debt”.

But be careful, the situation can quickly degenerate if you are not vigilant.

The secret when it comes to debt is never to have a debt ratio that exceeds your total repayment capacity. If this is the case, then we speak of over-indebtedness. This can quickly become problematic, especially if you are no longer able to repay the amounts you owe, within the time allowed.
Before finding yourself trapped in a critical situation, it is best to calculate your “debt ratio”, to reassure you first, but also obviously, to reassure your lenders.

What is the debt ratio and how to calculate it?

When you want to take out a loan, the banks need a detailed view of your finances to determine if you can repay the sums you are looking to borrow, for this, they will check your debt ratio. The debt ratio is a measure that helps determine the relationship between your debts and your income.
To find out, simply compare your monthly income to all of your debt repayments over one month.

The debts to consider are all of what you have to repay monthly: mortgage, car loan, personal loan, alimony, or even credit card repayments, etc. Then simply divide the total amount of debts by the total amount of income and multiply by 100. You get a percentage that corresponds to your debt ratio.

Example :

Total monthly payments
(including mortgage, credit card, line of credit, and any other repayments)
Total monthly income before taxes
(including salary, alimony, and other cash receipts)
Debt ratio: 3000: 5000 X 100 = 60%

What is the acceptable debt ratio to consider my finances healthy?

A debt ratio equal to or less than 30% is considered excellent and no financial institution will be cautious if you wish to take out a loan. This debt ratio proves that you manage your expenses masterfully and that you will repay your loans without difficulty.

A debt ratio that is between 30 and 36% is considered good, but you will still have to start monitoring your expenses and not engage in unnecessary purchases.

Above 36%, and if you exceed 40%, your debt ratio is considered at risk. The situation is starting to become critical and you will likely encounter difficulties in obtaining a new loan because you will have difficulty honoring your additional repayments.

If you find yourself in such a situation, meeting with a financial advisor might be an option to consider. He could offer you debt consolidation, for example, so as not to see your finances sink into an infernal spiral from which you would find it difficult to emerge unscathed.

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