A few simple calculations can tell you whether you're doing fine or staring at debt disaster. And be sure to see how your peers are handling their burdens as well
"It's not denial. I'm just selective about the reality I accept." -- cartoonist Bill Watterson
People in debt often fool themselves about how bad things really are. They think they can afford their obligations if they're able to swing the minimum payments. Or they assume their credit card bills are about average, when in fact they owe way more than the norm.
Many carry these illusions to the brink of disaster, realizing only too late how deep a hole they've dug for themselves.
Even if the truth won't set you free immediately, it should give you the motivation to stop digging and start paying off your debt -- or to get help if you're really in over your head.
To that end, here are four money ratios you should figure out so you really know where you stand.
Leverage ratio
Leverage ratios, which measure total debt against total assets, are used in investing to evaluate relative riskiness. The higher a company's leverage ratio, the riskier that company is as an investment.
The same holds true for household finances.
To calculate your leverage ratio, you'll want to total the outstanding amount of all your debts, including:
- All mortgages and home equity borrowing.
- Student loans.
- Vehicle loans.
- Personal loans.
- Other installment loans.
- Credit card debt.
- Other lines of credit.
- Payday loans, title loans, pawnshop loans and bounced-check fees owed to banks.
For assets, count the current value of your:
- Real estate (use Realtor.com or a similar service for a rough estimate).
- Vehicles (use Kelley Blue Book on MSN Autos or similar service for an estimate).
- Retirement accounts.
- Other investment accounts.
- Bank and credit union accounts.
- Life insurance (if the policy has a cash value).
- Net business equity, if you own a business.
- Other assets (gold, jewelry, collections or antiques).
Divide your debt by your assets to get your leverage ratio. For example, if your assets total $190,000 and your debts total $60,000, your ratio is 31.6%. Then compare your ratio with that of your peers:
| LEVERAGE RATIO | |||
|---|---|---|---|
By age of head of household |
By household income |
||
Under 35 |
44.3% |
Less than $20,600 |
13.5% |
35-44 |
28.2% |
$20,600 to $36,499 |
18.5% |
45-54 |
16.3% |
$36,500 to $59,599 |
24.3% |
55-64 |
10.3% |
$59,600 to $98,199 |
25.3% |
65-74 |
6.5% |
$98,200 to $140,899 |
23.4% |
75 and up |
2.2% |
$140,900 and up |
8.4% |
All households |
14.9% |
Source for all charts: Federal Reserve's Survey of Consumer Finances, 2007.
Ideally, your leverage ratio will be lower than the average for your age and income and decline over time. If your ratio is high, you need to take a look at how affordable your debt is and what makes up that debt. Read on.
Debt-to-income ratio
A debt-to-income ratio measures how much of your gross income is eaten up by debt payments. To calculate it, add the minimum payments required on all your various debts, including your mortgage, each month and divide it by your monthly pretax income.
Once again, compare the ratio with that of your peers:
| DEBT-TO-INCOME RATIO | |||
|---|---|---|---|
By age of head of household |
By household income |
||
Under 35 |
19.7% |
Less than $20,600 |
17.6% |
35-44 |
18.5% |
$20,600 to $36,499 |
17.2% |
45-54 |
14.9% |
$36,500 to $59,599 |
19.8% |
55-64 |
12.5% |
$59,600 to $98,199 |
21.7% |
65-74 |
9.6% |
$98,200 to $140,899 |
19.7% |
75 and up |
4.4% |
$140,900 and up |
8.4% |
All households |
14.5% |
Most families devote 20% or less of their total incomes to debt payments, according to Federal Reserve statistics. Lenders traditionally like to see debt-to-income ratios of no more than 36%.
If your debt payments consume more than 40% of your income, the Fed considers you to be in financial distress. More than one in six families overall and one in four low-income families are in this sinking boat:
| FAMILIES IN DEBT DISTRESS | |||
|---|---|---|---|
By age of head of household |
By household income |
||
Under 35 |
15.1% |
Less than $20,600 |
26.9% |
35-44 |
12.7% |
$20,600 to $36,499 |
19.5% |
45-54 |
16.0% |
$36,500 to $59,599 |
14.5% |
55-64 |
14.5% |
$59,600 to $98,199 |
12.7% |
65-74 |
15.6% |
$98,200 to $140,899 |
8.1% |
75 and up |
13.9% |
$140,900 and up |
3.8% |
All households |
14.7% |
If your debt-to-income ratio is more than 40%, you need a plan to deal with your debt. If you can't figure out a way to pay it down on your own, consider making an appointment with a legitimate credit counselor (you can get referrals here) to discuss your budget and whether a debt management plan could help. You'll find more information in "The consumer's guide to credit counseling."
If your situation is critical -- you've fallen behind on your debts, you're being sued by creditors or you have more credit card or medical debt than you can pay off in five years -- you may need to consider bankruptcy. (See MSN Money's bankruptcy guide for more.)
You also should seek help if:
- You can't pay more than the minimums on your credit cards.
- You're borrowing from one card to pay another.
- You're using payday lenders.
- You're late making payments.
- You've maxed out any of your cards.
Bad-debt-to-income ratio
Not all debt is bad. Moderate amounts of mortgage or federal student loan debt can help you build wealth over time, so you often don't need to rush to pay off these types of debt.
What you really want to tackle first is bad, or so-called toxic, debt. This debt typically has high or variable interest rates and doesn't help you build wealth. Bad debt includes:
- Credit cards.
- Retailer cards.
- Payday loans.
- Pawnshop loans.
- Title loans.
Total your bad debts and compare that to your gross income to come up with your own ratio.
The ideal amount of bad debt to have is none. If your bad-debt-to-income ratio is 6% or less and you're paying it down, you're on the right track. If it's any higher, you need to get serious about knocking out this debt. (For more, read "6 steps to dumping toxic debt.")
| CREDIT CARD DEBT | ||
|---|---|---|
By age of head of household |
Households with debt |
Median debt |
Under 35 |
48.5% |
$1,800 |
35-44 |
51.7% |
$3,500 |
45-54 |
53.6% |
$3,600 |
55-64 |
49.9% |
$3,600 |
65-74 |
37.0% |
$3,000 |
75 and up |
18.8% |
$800 |
All households |
46.1% |
$3,000 |
By household income |
Households with debt |
Median debt |
Less than $20,600 |
25.7% |
$1,000 |
$20,600 to $36,499 |
39.4% |
$1,800 |
$36,500 to $59,599 |
54.9% |
$2,400 |
$59,600 to $98,199 |
62.1% |
$4,000 |
$98,200 to $140,899 |
55.8% |
$5,500 |
$140,900 and up |
40.6% |
$7,500 |
Your daily interest costs
If nothing else inspires you to tackle your debt, maybe this will. You're going to see how much it costs you on a daily basis to remain in debt.
If you have mortgages or student loans, your lenders sent you 1098 forms summarizing how much interest you paid last year. Gather those.
Add to that any interest you paid on car loans and other installment loans. If the interest you paid last year is not clear from your statements, you can use an amortization calculator like this one. (Bankrate.com labels it a mortgage amortization calculator, but the math is the same on any installment loan. Just put in the initial amount you borrowed, the interest rate and the term of the loan, then click "Show/Recalculate Amortization Table," and add up the interest paid for last year.)
Then add in your credit card interest. You can total the finance charges from each month or, if your debt doesn't vary that much, use a recent month's interest charges as an average and multiply by 12.
If you took out any payday, title or pawnshop loans, add in that interest as well. Also include any bounced-check fees from overdraft transaction, since that's another cost of borrowing.
Have your annual total? Divide it by 365, and see how much more money you'd have every day if you were out of debt.
Let's say your total monthly interest cost average about $1,000. That's $12,000 annual, or more than $42 a day that could be spent on other things that are so much more fun.
Ready to tackle your debt? The resources in MSN Money's Debt Management Decision Center can get your started.
