The recession has put thousands of people in a financial hole and many are struggling to dig out. But there is a simple formula you can use to figure out if your debt is manageable or if you're headed toward financial disaster.
A leverage ratio is a percentage that measures your total debt against your total assets. Simply put, it measures your financial health.
Obviously the less you owe the better, but understanding the importance of a lower percentage could save you money and headaches
To measure your leverage ratio just divide your debt by your assets and that gives you a percentage. Let’s say you have $190,000 in total assets, your debt totals about $60,000, your debt ratio is 31.6 percent.
According to financial planner Jonathan Powers, that is about where you want to be. “You can use higher ratios but I like 30 because it typically gives you a cushion, a financial cushion for unexpected things that may come along so that your not strapped financially on a monthly basis," says Powers.
Your assets include things like your house, car, retirement accounts, bank and credit accounts, and business equity if you own one.
Your debt is anything you owe money on like credit cards and loans. Powers says the younger you are, the more likely you are to have a higher percentage because you have more financial responsibilities; just don't over do it.
"Every individual is going to know when they can no longer meet their monthly obligations. I believe once you exceed 40 percent, that you're at risk. I mean things would need to work out perfectly for you to meet those monthly obligations,” says Powers.
The formula doesn't solve your problems but it may help bring some to light.
Powers says, “That ratio is a good way to measure, well how do I stand financially, right now and what changes perhaps to I need to consider making in order to improve that ratio if it isn't where I want it to be."
If you calculate you leverage ratio and that number comes out much higher than 30 percent, Powers says the first thing to do is work on paying off the highest rate balances first, that is often your credit cards.
Also look at some ways to consolidate your debts and reduce some of the rates to allow more of your payments to go towards the principal.
Also, look at where you spend money and figure out where you can cut back.
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