Check out our new documentary DEBTASIZED.

Check out our new documentary DEBTASIZED.

4 Personal Finance Ratios That Measure Your Debt Risk

4 Personal Finance Ratios That Measure Your Debt Risk

Many people we meet are surprised to find themselves so far behind financially they can no longer pay their bills. The problem with debt is that it creeps up on us slowly.  Today we are going to take a lesson from the business world and apply it to personal finance. Businesses use financial ratio analysis all the time to assess their financial risks. Today we are going to look at 4 personal financial ratios that can help you measure your debt risk and determine some financial priorities. 

Debt-to-Income Ratio

The debt to income ratio tells you how much of your monthly income is consumed by debt repayment.

Debt-to-income ratio = total amount spent on debt repayment each month / total monthly household income.

When calculating your debt-to-income ratio include all income sources such as your pay, child support, pension income and any side income you earn.  

Debt payments would include credit card payments, car payments, student loans, bank loans, everything including your mortgage payment.  If you rent, add in your monthly rent as a proxy for a mortgage payment.

Why you should measure your debt-to-income ratio 

You may believe that your finances are OK because you’re able to maintain debt payments, but unless you stop to understand the relationship between your monthly income and debt obligations, you won’t know for sure whether you are paying too much towards your debts and are at risk of financial trouble.  Many of the people we meet use too much of their income to support debt payments only to find themselves borrowing more debt to make ends meet. Constant borrowing creates a debt cycle that can lead to the need to file bankruptcy or a proposal to deal with excessive debt levels.

Ted suggests keeping a close eye on your debt-to-income ratio and watching for whether or not the ratio goes up. While every financial situation is different, we recommend a debt-to-income ratio of 30% or less. 

Calculate your ratio: Debt to Income Ratio Calculator

Coverage Ratio

A coverage ratio is your ability to pay for all your monthly expenses after a sudden loss of income. You want to know how much of your monthly costs are covered by all your available cash or cash equivalent assets.

Coverage ratio = liquid assets / total monthly expenses.

Liquid assets are assets which you can convert to spendable form quickly. Liquid assets would include cash, accounts like tax-free savings accounts or money in your chequing account. Liquid assets do not include assets you have to sell like boat or a coin collection, or long term investments like a GIC or mutual fund because they take too long to redeem.

Why knowing your coverage ratio matters 

Knowing your coverage ratio helps you understand how long you can pay your bills without relying on additional debt. Effectively this is your emergency fund

Ideally, a good coverage ratio means having enough liquid assets to cover 2 to 6 months worth of living expenses if you lost your job. How much you need depends on the number of earners in your household, the stability of your employment and access to credit. You need enough coverage to give you time to find new work with minimal financial stress.

Current Ratio

A current ratio is very similar to the coverage ratio but instead of looking at how long you can cover your monthly expenses without relying on added debt, a current ratio measures how long until you start to default on your loan payments if you had to rely on your assets alone to keep up with your debt payments. 

Current ratio = liquid and sellable assets / one year’s total debt payments.

Unlike with a coverage ratio, where you could only include liquid assets, in a current ratio, you can include any assets that can be converted into cash within a year.  Your debt payments would consist of one year’s monthly installment loan payments (like your car loan), mortgage or rent payment and expected minimum monthly debt payments on your credit cards, lines of credit and payday loans.

To illustrate:

Let’s say you have $4,000 total after selling and liquidating any assets you can. We will also assume that your total monthly debt payments for one year are $4,000. This means, your current ratio is 1. In other words, you could keep all your debt payments current with your cashed in assets for one year. After that one year, you will begin to default on loan payments because you will have run out of cash. 

If you have a ratio of 50%, that means you only have enough capacity today to cover debt payments for 6 months from available resources. The lower your current ratio, the less time you can keep your bill payments current. 

Why your current ratio matters

When you fall behind on debt payments, collection agencies start calling. These calls are harassing and stressful. In some cases, lenders have the right to increase your interest rate, apply penalties and even call your loan if you default. Defaulting on a secured asset like a car or home could mean forfeiture of the asset.

Demand Debt Ratio

Demand debt, or callable debt, is debt that your lender can demand you pay back at any time. Loans like an unsecured line of credit, a home equity line of credit, credit card debt and payday loans are all demand debt. Demand debt does not include fixed loans like a mortgage or car loan because they have a set repayment term by contract. 

The demand debt ratio will show you your ability to get rid of debt if you need to.

Demand debt ratio = liquid and sellable assets / total demand debt

For example, let’s say your cash and sellable assets total $10,000, while your credit cards, payday loans, and other demand debts total $20,000. Your demand debt ratio would be 50% because you would only have half of the assets you need to repay all of your demand debts. 

Why your demand debt ratio matters

Having more demand debt than you can repay is dangerous. If you lender demands you repay the loan you may be unable to do so without sufficient current assets.  

Using Debt Ratios to Make Decisions

If too much of your income goes towards debt payments each month, find ways to pay down that debt to reduce your risk in the even of a job loss or income reduction.

If you’ve learned that you don’t have enough money saved to pay your living costs for long without relying on debt and you are worried about the stability of your employment, then put more focus into having a stable emergency fund.

If you’ve just learned that you owe a lot of demand debt put any extra money towards paying off demand loans since they put you at high risk of default and they are expensive to maintain.

Lastly, if you find yourself relying on payday loans or any other form of debt to make ends meet this is the worse situation to be in.  Consider speaking to a Licensed Insolvency Trustee to review your options for eliminating high-interest demand debt. 

I recommend that you use these personal finance ratios regularly, as your personal financial situation changes. Other personal finance ratios measure your overall financial health like savings rate and net worth ratios. Once you tackle your debt, you can move on to learning about these ratios to help you build up your finances and accumulate wealth in the future.

For more detailed information on debt ratios, tune into the podcast or read the complete transcript below. 

FULL TRANSCRIPT – Show 234 – 4 Personal Finance Ratios That Measure Your Debt Risk

4 Personal Finance Ratios That Measure Your Debt Risk

Doug:                Most people who go bankrupt or file a consumer proposal didn’t see it coming. It’s a shock when they get to the point where they can’t pay their bills. They know they’re getting behind but they assume they can get caught up. They don’t realize how far behind they are until it’s too late. Is there an early warning system for financial problems, are there numbers you can look at to see if there’s trouble ahead? Yes, yes there are.

                          In fact, based on my over 30 years as a financial advisor, I think there are four key financial ratios that can warn you about oncoming trouble. As an accountant I’m quite familiar with financial ratio analysis. Businesses use financial ratios to assess their performance and financial strength. Financial ratios provide insight and can spot financial problems early. I meet with a lot of people who are surprised to find themselves suddenly facing debt problems. So why not apply the same ratio analysis to assessing your debt levels?

                          Today, with the help of my Hoyes Michalos co-founder and business partner, Ted Michalos, we’re going to look at four financial ratios that can help you measure your debt risk. There are other ratios that measure your overall financial health like savings rate and net worth ratios but this is a podcast about dealing with debt. So we’re going to focus on the top personal financial ratios that will show you if you have too much debt or if your debt is manageable. As we go through them play along at home, calculate your own ratios and see how you rate okay Ted ready to talk numbers?

Ted:                  Let’s do it.

Doug:                Okay, so let’s start with the basics. Why look at ratios rather than hard numbers like how much debt I have?

Ted:                  Ratios make it easier to see the relationship between two numbers. So it’s not just how much debt you have, but how much debt you have in relation to how much you earn and the assets and the expenses that you have so it gives you something to compare.

Doug:                So okay, so give me an example.

Ted:                  So I mean you’ve got somebody with $20,000 of unsecured debt, for some people that’s completely unmanageable and for other people they can handle it quite easily. So just knowing how much debt you have doesn’t help you need well, like the example that you’re thinking of.

Doug:                So, okay I got half a million dollars on a mortgage, is that a big number?

Ted:                  Well so if your house is worth half a million dollars it’s a huge number. If your house is worth two million dollars it’s not so bad.

Doug:                So that’s why we’re looking at ratios because you’ve got to compare it to something else, a raw number doesn’t really tell you anything. Okay, so I said that there are four really personal debt ratios, so let’s go through them, what they are and how they can help someone assess their situation. And for those who are listening or watching there’s no need to write all this down, we’ll put all the ratios and explanations in our show notes.

                          So I’m going to start with one of the most important ratios, this ratio is sometimes referred to as the debt to income ratio and sometimes as your personal debt service ratio. This is one of the problems with these things; people come up with different names to explain the same thing.

Ted:                  Which one have we trademarked?

Doug:                Well, yeah we haven’t trademarked any of these. These are not things we’ve invented, they’ve been around forever. A debt to income ratio tells you how much of your monthly income is consumed by debt repayment and we’ll explain this because there are some nuances to it. And the calculation is pretty simple; it’s the total amount of debt you spend on debt repayment each month divided by your total household income.

                          So, you want to include everything so you include all your sources of income, you know, your paycheques, child tax benefits, support payments, pension incomes whatever and then all of your debt payments, credit cards, car payments, student loans, bank loans, everything including your mortgage payment. Now this is the way we do it, well you can do it however you want but when we think of this we include your mortgage payment, which means that if you don’t have a mortgage you have rent, well include your rent then, that’ll put you in comparable terms. Again, you can calculate it how you want, that’s how we do it.

                          So, math time, and these are easy questions so you don’t need a calculator for them. Let’s say my house income is $3,000 a month.

Ted:                  Your household income is $3,000 a month.

Doug:                Thank you very much. And my debt payments are $1,500 a month. So, what is my debt to income ratio.

Ted:                  So half of your income’s going to debt payments, so your debt to income ratio is 50%.

Doug:                And again that’s the way we do the math some people are saying well isn’t it really two to one? Well, okay we’re doing it the way we’re doing it. So 50% is your debt to income ratio.

Ted:                  Well and to answer that question the reason we’re doing it that way, the closer you get to one the worse off you are. It’s easier to understand. So the example where you flipped it over and your debt to income is two to one that actually sounds good, whereas we’re trying to impress upon you that you want the smallest number possible.

Doug:                So is three to one, four to one? It gets confusing. So you’re right keep that in mind that one is a bad number here. So, now we do a detailed analysis of all of our clients every year and we are recording this in February, 2019. We’ll be releasing our updated study later.

Ted:                  That’s a secret, we don’t tell people that.

Doug:                That’s right, oh it’s a secret. It’s going to be released and we’re going to update all these number but here’s what I can tell you. We have a pretty good understanding of what debt levels get people into trouble. So simple question then, what is the best to income ratio?

Ted:                  Zero, no debt.

Doug:                Zero, no debt. And okay that’s kind of obvious and unfortunately it’s not really realistic for people who have a mortgage or a car loan or a student loan or anything else. So let’s kind of look at it piece by piece then, up to what level wouldn’t be too bad?

Ted:                  Okay, most financial professionals, and I’m talking about bankers now, loan officers, whoever, will tell you that 30% or less is an acceptable level of debt to income ratio. So it’s not a huge chunk of your income, it’s still a manageable amount.

Doug:                So if I make a thousand bucks a month, $300 bucks of it is going to debt repayment so I’ve got $700 to pay all my other expenses. Okay, it’s a liveable thing. So okay, if 30% or less is okay, then when do you get into the worry zone then?

Ted:                  Okay, so 31 to 42%, let’s use that number. It means now you’re spending a significant portion of your income servicing your debts, 42% is a big number.

Doug:                It is and the risk is if you have variable rate debt. So things like lines of credit, you know, a mortgage that’s on a variable rate, you really want to start working to reduce your debt now because you’re into that worry zone.

Ted:                  Right.

Doug:                And the, I guess the other risk is if you’re only making minimum payments.

Ted:                  Well the debts going to on forever and think of the interest that you’re paying.

Doug:                Yeah and so the fact that oh well, I’m at 32% I guess I’m in the worry zone but, you know, okay if that’s all minimum payments that’s an issue. Again, I said we crunch a lot of numbers with our clients, it might be interesting for people to know that our average client pays 33% of their household income in interest alone.

Ted:                  Yeah and just as a reminder folks our clients are folks who have declared themselves to be insolvent. So, they got serious debt problems. If you’re in this category you really ought to be talking to somebody.

Doug:                Yeah and we’re talking apples and oranges here because you said the worry zone is 31 to 42% and I’m saying 33% of our clients –

Ted:                  That’s just interest.

Doug:                That’s just interest, that’s not paying any principle so that’s a huge problem. And of course if all you’re doing is paying interest it just keeps going up and up and up and up. So interest only is – I mean that’s a disaster.

Ted:                  Yeah, it’s a train wreck waiting to happen.

Doug:                You’re never getting yourself out of debt. And of course this is something that the banks are quite happy for you to do.

Ted:                  Well, that’s a balancing act too but that’s another program.

Doug:                We’ll leave that one aside. So, if you’re paying more than the minimum and your credit card’s great, you can adjust the sensitivity of our recommendations obviously to figure out what makes sense to you. So let’s get back to this debt to income ratio. So 30% or less I’m in good shape, 31 to 42% okay, now I’m starting to get into the worry zone. You might not have a problem, you might, what happens when I get into that, you know, 42% number.

Ted:                  So 43 to 49% we’re calling that the danger zone. Any variation in your income if something goes wrong you’re probably not in a situation where you can deal with it. There’s no room to wiggle.

Doug:                Now these are the people, and you already made the comment if you’re in these zones you want to talk to someone, this would be the zone where we do a lot of consumer proposals.

Ted:                  Correct.

Doug:                You’ve got income and that’s what’s really necessary to file a proposal.

Ted:                  Well, and the beauty of the proposal is you’re now, you’re repaying a portion of the debt so we drop that service ratio from the 50% danger zone to below 30% where you can manage it. That’s the objective.

Doug:                That’s the whole point. So, okay I can kind of figure out what the answer to this next question is. I’m guessing over 50% this is a problem then.

Ted:                  It’s almost impossible to maintain. If you’re – more than half your income is going to servicing debts, unless your income is ridiculously high and your living costs are low it’s just not sustainable.

Doug:                Yeah, so you’ve seriously got a problem and you obviously have to deal with it once you get to that level.

Ted:                  And we’re seeing more and more seniors in this category. They’ll do anything to make sure they service their debts, which mean they take on more debt, payday loans, instalment loans just so they can make the payments on the debt they have and then they get to the point where half their pension’s going to pay for debts, it’s just not sustainable.

Doug:                Yeah. And half of the calculation when you’re looking at debt to income is income and what do we know about seniors and their income?

Ted:                  It’s not going up.

Doug:                Yeah it’s, in a lot of cases it’s fixed, you’re on a pension, it’s not changing.

Ted:                  And it’s lower than what they were used to, right?

Doug:                Yeah, my pension is probably less than when I was working. Okay so the higher the ratio the worst it is. Now I know there’s some people listening saying okay, you’ve had your 2019 prediction show and that was the show that Ted blurted out that he thinks insolvencies are going to go up 10% this year.

Ted:                  How much were they up in January.

Doug:                Well no comment. We actually don’t know the numbers yet from the government and of course every news outlet picked that up because I guess all the reporters listen to our show and it was all over the newspapers and everything that insolvencies going way up.

Ted:                  And remember some of them said that I was wrong, I was low.

Doug:                I know and in fact it may end up being that you were low.

Ted:                  We’ll see.

Doug:                So on that show, in addition to that inflammatory comment that you made, we also talked about the debt to income ratio was up to $1.78 for every dollar of disposable incomes that Canadians have. So every dollar of disposable income they owe $1.78 in debt. So why are we saying it’s dangerous to be over 30% but the ratio is $1.78, this is confusing here.

Ted:                  Alright, so we’re looking at two distinctly different things. The first one, the debt to income ratio is looking at your monthly income.

Doug:                Monthly.

Ted:                  And your monthly debt payments. The other’s looking at your annual disposable income and the total debt that you’re carrying. So it’s apples to oranges here.

Doug:                Yeah, they’re not measuring the same thing.

Ted:                  That’s right.

Doug:                Debt to income ratio is comparing your month income to your monthly debt payments, which of course is a percentage.

Ted:                  So if I had $3,000 of income and I was paying $1,000 towards my debts, my debt to income ratio is 33%, a third. If I earned $10,000 a year, my first job actually was at $11,000 a year, tells you how old I am. Anyway, if I was earning $10,000 a year and I have $17,800 worth of total debt then I’ve got $1.78 a debt for every dollar that I earn.

Doug:                So we’re looking at two different things. And so that’s why when you hear numbers quoted in the media you’ve got to understand what exactly are they talking about here.

Ted:                  Well and the most important thing with any of these ratios is that you don’t look at them as a static number. You’re looking for changes over time. So the things that’s so scary about this $1.78 is it just keeps going up, it gets higher and higher and higher.

Doug:                Yeah, you’re right. A $1.78 doesn’t mean anything unless you realize a few years ago it was $1.70, $1.60, $1.50. And it’s the same with your own personal debt to income ratio, well if I was always under 30% and now I’m up into the 50s it’s the trend that’s really damaging.

Ted:                  That’s right it’s a warning sign.

Doug:                And I think the other reason $1.78 keeps getting quoted all the time is because that’s great for looking at the Canadian economy as a whole. How much debt are we all carrying? It’s a big picture number. But I don’t really care frankly about how the entire Canadian economy is doing, I’m much more interested in individual people, that’s who we help. What’s your number, what are we looking at? So if you want to see if you have too much debt based on your debt to income ratio, you know visit our website, we’ve got an online calculator there, you can punch your numbers in and we’ve got a link to that as well.

                          Okay, so we’ve talked about debt and income but that doesn’t tell the entire story. It doesn’t tell how successful I’ll be at covering my debt payments. So there’s obviously a ratio to do that. It’s called the coverage ratio and there’s a few different ways to view this so tell me about the coverage ratio.

Ted:                  This is one that almost no one ever talks about. And what we want to focus on here is what’s your ability to actually cover your living expenses and your debts? So, if you – the example we’ve been using $3,000 a month worth of income, $1,000 worth of debt, that means 33% at the income ratio. That leaves you 67% of your money to pay your bills. Is that enough? The only way to really know if a debt to income ratio is risky or dangerous for you is to know how much money you’ve got available to pay those debts.

                          So we’ll look at what are your living expenses every month, your rent, your groceries, your car payment, all the things you need to pay in order to survive? And that ratio, you want that number to be as low as possible as well. The closer you are to one it means more of your income you’re using to pay your living expenses doesn’t leave you anything to service your debts.

Doug:                Yeah so the coverage ratio shows your ability to pay for monthly expenses and it’s particularly good after a sudden loss of income for example due to a job loss. So, the actual math would be to take all of your liquid assets and divide it by your monthly expenses. So what do we mean by liquid assets?

Ted:                  So liquid assets are things that can be easily turned into cash. So, it’s tax free savings accounts, investments that are easily convertible so GICs, that sort of thing. It doesn’t mean your antique car, your coin collection, things that will take a little bit of time to sell.

Doug:                Yeah and even a GIC if it’s locked in for five years, well okay I guess that’s technically not liquid. I guess you could cash it in and lose some of the interest or something. So, you would not then include stuff you can sell like an antique car or something like that.

Ted:                  And the reason you don’t include those things is because you can’t do them quickly enough or if you do do them quickly you’re going to take such a hit they’ll sell it below value and that doesn’t make sense.

Doug:                So, we’re kind of really looking at my emergency fund then. What could I access really quickly?

Ted:                  Yep.

Doug:                Okay so what is a good coverage ratio when we’re looking at being able to cover my debts?

Ted:                  So historically financial planners have always said you want two to six months worth of liquid assets. You want to be able to carry two to six months of living expenses. There are very few people that can do that anymore.

Doug:                Yeah, so the analysis would be if I lost my job tomorrow.

Ted:                  Right, how long could I survive?

Doug:                How long can I survive? Okay, so how much is my rent and how much is – and again there’s two different ways of looking at the coverage ratio. One is paying all my expenses, rent and groceries and everything else and the other is well even just to cover my debts how long would it be? So, obviously how much you need obviously depends on a number of factors. Is there other income in the household, the stability of your jobs and, you know.

Ted:                  Well and years ago people stopped saving so much because they just don’t have the ability to save because the cost of living is so high. And so a secondary strategy developed where maybe you just to have a line of credit or a large credit card that you only ever use in emergencies. That becomes your liquid asset so to speak. The problem with that of course is it is not a liquid asset, it’s more debt.

Doug:                So you don’t consider a line of credit the same as an emergency fund.

Ted:                  Correct. I mean if it’s all you got, great. But it doesn’t replace it it’s a temporary fix until you can save enough money to have an emergency fund.

Doug:                And that’s the key point, it’s a temporary fix. So okay, I lost my job, I’ve got a line of credit great, I can pay my rent, cover my other debts but at some point I max out on that and all I’ve done is delayed the inevitable then.

Ted:                  Well and the worst case example is you’re already carrying a bunch of debt and you’ve kept this one line of credit as your safety net and you tap into it, now you’ve got even more debt. So you’re just creating a situation that’s unsustainable.

Doug:                Well, which brings us to our third ratio then, which is the current ratio. Now the current ratio is very similar to the coverage ratio you were just talking about it. But instead of looking at how long you can cover your day to day expenses without turning to debt, it measures how long until you start defaulting on your loan payments if you experience a job loss or some other income shock.

                          So obviously default isn’t good, that’s when collection calls start or you have secured debt like a car loan or mortgage, it’s when you risk losing assets and you can’t catch up. So the math is you take your liquid assets, like we did in the old one, the previous one, but we also take your sellable assets and we divide that by one year’s total debt payment. So this time in addition to cash on hand and, you know, cash equivalence you’re going to add in assets you can easily turn into cash with a year. So your example of your antique tractor, well okay that would be part of your sellable assets.

                          So short term debt payments is the other side of it, one year’s monthly instalment payments. So you’ve got a car loan, you pay $500 a month well that’s $6,000 over the course of a year, mortgage, rent payments, expected monthly minimum debt payments on your credit cards, lines of credit all that. So, back to math then so let’s say I’ve got $1,000 in my savings account I’ve got $1,000 in my TFSA, I got $1,000 in some investments and let’s say that the minimum payments on my credit cards over the next year would be $3,000, pretty simple math. What’s my current ratio?

Ted:                  So you’ve got $3,000 worth of savings and investments, $3,000 worth of payments, your ratio is one to one.

Doug:                One to one. So what is a good ratio then? What should I be targeting, what’s a good current ratio?

Ted:                  Well, so one to one means that you could go a whole year, which most planners would tell you is overkill. It’s great if you can get there but it’s not necessary. A ratio of 50% means six months. That’s a very good ratio but again most people can’t focus on two months as a starting block so that’s 17% or less. If you can’t get back on your feet in two months then we’ve got to look at longer term strategies anyway.

Doug:                So the higher the better on the current ratio. Okay, so final ratio and to explain this I want to start with a question and we’ve talked about this on many shows.

Ted:                  You’re going to wind me up.

Doug:                Yes, this is the wind me up question for Ted. What kind of debt is the worst?

Ted:                  High interest callable debt. So, let’s – the absolute worst, payday loans, hands down, absolute worst. Instalment loans, same category, credit cards maybe next.

Doug:                And they’re the worst because they’re high interest but because the bank can change the rules any time. That’s what a demand –

Ted:                  They can ask for your money today.

Doug:                And that’s what a demand loan is, they can demand payment or more likely they can change the terms any time they want, they can jack up the interest rate, whatever. And so of course we have a ratio to look at your ability to handle and repay your demand loans. So guess what the ratios called?

Ted:                  The demand debt ratio.

Doug:                You got it, demand debt ratio. And of course everybody who’s following along has already figured out how to calculate it. It’s your liquid and sellable assets divided by your total callable debt. So, in the current ratio, which is the one we just talked about we were only looking at a year’s worth of payments. In the demand debt ratio we’re looking at all of your callable debt, not just one year’s worth of payment. Okay, what’s the point of that, what does that show?

Ted:                  Well it tells you your ability to get rid of your debt. So, it’s a good indicator if you’ve just over extended yourself or you’re living in credit all the time. Because if your callable debt exceeds your income you got a problem.

Doug:                You’ve got a problem. Okay so back to math time then, so my cash and other liquid and sellable assets are $10,000. And my credit cards and payday loans and other callable loans are $20,000. So this is not my monthly payments this is the total of all my debts.

Ted:                  All these bad things that you have.

Doug:                All my assets all of my debts in – so what would my demand ratio in that case be?

Ted:                  One half or .5 because you only have half enough money to cancel all your callable debt.

Doug:                So pretty simple to figure out. So if I took everything I had and turned it into cash and then the next day the banks say we want all our money and we want you to pay off your line of credit, your credit cards, payday loans and any other short term debt. We’re not talking about mortgages here, we’re talking about short term debt, anything where the lender can just change the interest rate or demand payment. I mean it doesn’t include fixed loans like a mortgage because if you’ve got a five year term on your mortgage, the bank can’t just come to you tomorrow and say oh we want our money.

Ted:                  Yeah or a car loan or anything like that.

Doug:                Or a car loan, yeah. It’s a fixed term, whereas a line of credit or a credit card is not, they can demand payment at any time. So, that way you know what the payments will be, they can’t demand it. So, I assume then what’s the best demand, debt ratio?

Ted:                  Zero.

Doug:                Zero, which would mean you don’t have any debt.

Ted:                  Okay, so if you have high interest debt like credit cards and payday loans you need to put extra money towards retiring that debt. If you’ve figured out what the trend of this whole program, is you’ve got to deal with these things that are the most expensive, the most awkward, the ones that put you the most at risk.

Doug:                Which is kind of the theme of every single program we do. We’re just coming at it from a different angle today.

Ted:                  So flip this over though, so if you’re trying to decide, particularly at this time of year should you be putting money in a savings account, saving for tomorrow but you’re carrying credit card debt, pass the credit card debt. Credit card debt is 19%, the best you’re going to get on a GIC today is what, 2%? It just doesn’t make any sense.

Doug:                Yeah, why would I be saving at 2% when I’m paying 19% after tax? It really doesn’t make a whole lot of sense. So, okay the overall theme then is pretty simple. Take a look at these numbers and chip away at the debt.

Ted:                  Yeah and remember what we said is looking at the number once is not really any utility to you. You’re looking at trends over time. So what you want is these ratios to be improving. So, that means in each of these ratios you want the smallest number possible. So if you’ve got a debt to income ratio of one to one that’d be very bad, you want it to be, well we said our target is 30%, I’d like it be to be zero, that’s what you want to shoot for.

Doug:                And so you want your trend to be going down and you also want to compare, like certainly with the debt to income ratio where everyone else is standing.

Ted:                  That’s right.

Doug:                And so as we said our clients, I mean they’re paying a third of their income just in interest. So if you’re in that same boat then you’ve probably got an issue and that’s where you need to be reaching out for help.

Ted:                  Right and we didn’t mention the book today.

Doug:                Oh we didn’t? You mean Straight Talk on Your Money.

Ted:                  Well, you didn’t talk about ratios in the book because you weren’t trying to intimidate people with numbers, right?

Doug:                I did not so on our next show I will plug the book a lot more. Excellent Ted, thanks for being here. So to summarize, we picked four ratios that focus on debt. There are other personal finance ratios that other financial experts or your bank or mortgage broker will look at but these are four ratios that we pick to help you, not to help a bank because that’s really what we want.

                          So, we want you to know how risky your situation is so you can decide whether or not you can weather an unexpected life event. The debt to income ratio tells you how much of your monthly income is consumed by debt repayment, the coverage ratio shows your ability to cover your monthly expenses, even after a sudden loss of income due to a job loss or illness because it’s looking at your assets, not your income. The current ratio is similar to the coverage ratio but instead of looking at how long you can cover your day to day expenses without turning to debt, it measures how long until you start defaulting on your loan payments if you experience a job loss or some other income shock.

                          And finally the demand to debt ratio compares all your liquid assets to all of your callable debt, not just one year’s worth of payments, to give you a big picture view of your debt. I’ll put the formulas with each of these ratio along with a full transcript and a link to our free income calculator over at

                          That’s our show for today. Thanks for listening. Until next week I’m Doug Hoyes. That was Debt Free in 30.

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