Let’s say an unemployed acquaintance of yours, we’ll call him Jeff, asks to borrow $10 from you.
What do you do?
Immediately, with your $10 in your hand, you’ll ask yourself a bunch of questions about Jeff, including:
- Do I trust Jeff?
- Will Jeff pay me back?
- Whoa, why is the guy from Hamilton on the $10?
Hard to answer these questions, right? Now pretend a third person, your mutual friend Mary, tells you that Jeff borrowed $100 from her last week and hasn’t paid it back. Now what do you do?
You slip your $10 in your pocket and move on.
In a nutshell this is debt to asset ratio. Or, its cousin: debt to income ratio.
When you’re a business, your debt ratio determines how much lenders will be willing to give you AND it helps you be aware of how much you owe to creditors.
If you’re an individual, the debt to asset ratio won’t be as relevant to you…but your debt to INCOME ratio will be.
Mortgage lenders, bank loans, and anyone giving you credit will take a look at your debt to asset/income ratio in order to determine how much they’re willing to lend to you.
It’s so important to keep these numbers in mind to be aware of your debt (if you have any that is) because when they’re out of whack they can stifle your ability to make some big purchases.
But what makes up your debt to asset/debt to income ratio exactly? And what’s the formula to each? I’m going to answer all those questions in a bit — and if you’re a weirdo like me, you might even find the math behind it all exciting.
For businesses: What is debt to asset ratio?
(NOTE: If you’re not a small business owner or don’t run your own side hustle, you can skip this section to the debt to income ratio.)
Like your credit score, your debt to asset ratio is a number. One that shows you how much of your assets — things like your cash, investments, inventory, etc — were paid with debt including:
(Pretty much any instance that you owe money to someone.)
The way you calculate your debt to asset ratio is simple: Take the amount of debt you owe and divide it by the value of the assets you own. Then, take that number and multiply it by 100 so you get a percentage. That’s your debt to asset ratio.
It’ll look something like this:
Dollar amount of debt you owe ÷ Dollar amount of assets you own = Debt to asset ratio
Debt to asset ratio x 100 = Debt to asset ratio percentage
It’s really that simple.
What is good debt to asset ratio?
The higher your debt to asset ratio is, the more you owe and the more risk you run by opening up new lines of credit. According to Michigan State University professor Adam Kantrovich, any ratio higher than 30% may lower the “borrowing capacity” for your business. That’s why it’s so smart for you — especially if you’re a business owner or freelancer — to know what your debt to asset ratio is.
Many lenders such as banks and mortgage companies may use your debt to asset ratio to determine the amount they’re willing to lend you.
Let’s take a look at an example of debt to asset ratio in action.
Say you’re a small business owner looking to get a new loan for your venture. After totaling everything up, you find that you owe about $25,000 in debt and own about $100,000 in assets.
After dividing your debt by your assets and multiplying that number by 100, you discover that your debt ratio is 25%.
However, if those numbers were flipped (you owe $100,000 in debt and own only $25,000 in assets) your debt to asset number would be 400%.
For individuals: What is debt to income ratio?
If you plan on ever getting a mortgage for a house, you need to make sure your debt to income ratio is in check.
This number compares your gross monthly income to your monthly debt. Banks and other lenders look at this number to determine how much of a risk you are to lend to. The more of a risk you are, the less of a chance they’ll lend to you at all.
Much like your debt to asset ratio, calculating it is simple:
Dollar amount of monthly debt you owe ÷ Dollar amount of your gross monthly income = Debt to income ratio
Debt to income ratio x 100 = Debt to income ratio percentage
Let’s run an example scenario:
Say you owe about $1,000 in debt month-to-month and make $75,000 a year ($6,250/month). We’d then take 1,000 divided by 6,250 in order to get our debt to income ratio like so:
1,000 ÷ 6,250 = .16
Multiply .16 by 100 and you have 16% for your debt to income ratio….but what does that number mean?
What is good debt to income ratio?
The lower the number is, the better. According to SmartAsset.com, the “ideal bank to income ratio for aspiring homeowners is at or below 36%.” Many banks will still lend to you up to 43%.
So if your debt to income ratio amounted to 16% like in the example above, you’d be in good shape for a home loan.
If your debt to income ratio is a little higher and you want to lower it, though, I’d like to help you out.
After all, being in debt is the #1 barrier to living a Rich Life, and not only is it a financial burden, but it can also be a HUGE psychological burden as well.
For example, a while back I ran a survey of my readers who were in debt, asking them a seemingly simple question: How long until you’re out of debt?
Take a look at the results:
34% (the majority) of respondents DIDN’T KNOW how long it would take until they were out of debt.
If you’re too afraid to even open the envelopes that will tell you how much you owe, “information” is not what you need. Instead, that person has to be willing to take action THEMSELVES before anything will change.
If you’re reading this now, and you’re ready to take action against your debt, I want to help you.
In fact, you can start getting out of debt TODAY through a 5-step system I’ve developed.
NOTE: Though it’s just 5 steps, it can be a lot more difficult than you think. But if you’re willing to put in the time and work to be a Top Performer, I promise you you’ll be able to wipe out your debt in no time.
Wipe out your debt — and live a Rich Life
Eliminating debt is just the first step on the journey to living a Rich Life.
Download a free copy of my Ultimate Guide to Making Money to learn my best strategies for creating multiple income streams, starting a business, and increasing your income by thousands of dollars a year.
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