When it comes to personal finance, there are a lot of important metrics to keep an eye on. Whether you’re working with a financial professional or handling your funds yourself, calculating a clear picture of your situation involves an understanding of key ratios. One of the most helpful ratios is the debt to assets ratio.
As the name implies, your debt to assets ratio is a measure of how much of your assets are owned by creditors. The lower this ratio of debts to assets, the better. With the average household debt on the rise across Australia, it’s never been more essential to have a complete understanding of your debts as they relate to your assets and income. In this guide, we’ll discuss the equation behind debt to asset ratio so you can see for yourself how it’s calculated.
The Debt to Asset Ratio Formula Explained
To begin, let’s break down the debt to assets ratio formula as it relates to personal finances. In essence, this is a way to calculate a ratio indicating the portion of an individual or household’s total debt to its total assets. To do this calculation, you need:
- Total Debts: First, you need the sum of all outstanding debts, including things like credit cards, mortgages, car loans, etc.
- Total Assets: Next, you need the total value of all assets. This could be home equity, property, stocks, and so on.
From there, the formula is dividing the total debt by assets: Total Debt / Total Assets. You’re left with a number that serves as the debt to asset ratio.
For instance, let’s say a family has $100,000 in debt, including both credit cards and a mortgage. This same family also has an estimated $200,000 in assets in the form of vehicles, home equity, and savings. We’ll divide $100,000 / $200,000 to result in 0.5. This means the debt to asset ratio is 0.5, or 50% of the household’s assets are financed by debt.
What’s Considered a ‘Good’ Debt to Asset Ratio?
Now that we understand how to calculate the debt to asset ratio, what do we make of this number? How do you know what makes a debt to asset ratio ‘good’ or ‘bad’? Like most things personal finance, it depends. At the end of the day, this is just a number on a page. It can be a useful tool for assessing your current financial situation, but it’s only one piece of the overall puzzle.
The most common use for your debt to asset ratio is when seeking additional lines of credit or operating a business. In these cases, most investors and creditors feel a ratio between 0.3 and 0.6 is ‘good.’
A higher debt to asset ratio is considered more risky since this means you carry a larger percentage of debt. If you’re facing a higher percentage, it might be time to consider debt consolidation, a long-term payoff method, or another financial solution to increase your assets over time.
How to Improve Your Debt to Asset Ratio
If you’re concerned about your debt to asset ratio, don’t worry. There are many practical ways to improve your own household ratio now that you understand how it’s calculated.
- Create a budget: The first step to any financial journey is to create a clear budget. You need a strong, accurate understanding of your income and expenses. This is how you identify areas you can cut from your budget, as well as how much you need to set towards debt repayment.
- Boost your income: If possible, find new ways to boost your income. By repaying your debt faster, you have a direct impact on your debt to asset ratio. For example, you might try a side hustle or part-time job.
- Pay off high-interest debts: High-interest debts take a toll on your debt to asset ratio. Unlike low-interest debts, they take longer to repay and they get in the way of your long-term goals.
- Invest wisely: Finally, be smart with your investments. Investing in appreciating assets is a smart move, but you need to be careful with your money. Avoid risky investments, especially while you’re paying down debt.
The Impact of Debt to Asset Ratio on Financial Goals
Ultimately, you need to understand your debt to asset ratio if you want a strong financial future. It’s a key component of homeownership, retirement planning, investment, and long-term financial stability. When you maintain a strong debt to asset ratio, it reduces your stress as a whole. Having a safety net of economic comfort in times of instability is a blessing you can’t overlook.
Now that you understand your debt to asset ratio and how it’s calculated, you’re in a position to make it work for you. While it’s just one piece of your overall financial puzzle, it’s one of the most important parts of your financial well-being.
Are you wondering how your debt to asset ratio affects your economic outlook? The team at Debt Busters are here to help. Our skilled professionals will guide you through the next steps, assessing financial risk, and more. Contact us on 1300 368 322 to start today.