Financial Health Check: Do You Know Your Debt Asset Ratio?

What is a healthy Debt Asset Ratio, and how do you achieve one?

We all work hard for our money, so we can afford the life we want to lead. But in the midst of managing the demands of everyday life, we can forget to check in on our financial health.

As illuminating as it is, not everyone has the time nor disposition to sit down with a professional for a frank discussion on how things are, and where they’re likely to go if left unchecked.

Well, one quick and easy way to get a snapshot of your financial health is by checking your Debt Asset Ratio.

• What is debt asset ratio?
• How to calculate debt asset ratio
• Why you need to know your debt asset ratio
• What’s considered a good debt asset ratio?
• 4 tips to lower your debt asset ratio

What is Debt Asset Ratio?

Debt Asset Ratio is a commonly used financial marker that is used to describe the financial status of an entity. It may take the form of a number or a percentage.

When referring to a company, Debt Asset Ratio and Debt Equity Ratio describes the company’s debt compared to asset or value of shares (equity) respectively.

For individuals, Debt Asset Ratio or Debt Income Ratio have essentially the same meaning, and may be used interchangeably.

Simply put, the Debt Asset Ratio is a measure of debt versus assets or income. There are important implications, depending on how high the figure is.

How to calculate your Debt Asset Ratio

Step 1: Work out how much you are paying in debt repayment per month
This is a total of your unsecured debts such as credit cards, personal loans and credit lines, as well as outstanding loans such as student loans. If you have a mortgage that you are paying in cash (and not via CPF) add that in as well.

Step 2: Divide monthly debt total by your monthly income
This is your take home pay, after CPF, plus any regular income, say from side gigs, or investment dividends.

Step 3: Multiply that number by 100
This is to derive a percentage for your debt asset ratio.

Here’s a worked example on how to find your Debt Asset Ratio:

Calculation: 1200/4000 x 100 = 30

Why we do not use gross salary?

In calculating your Debt Asset Ratio, we use your net income (after CPF deductions) instead of your gross salary. This is because your CPF savings cannot be used to repay your debts, hence it should not be counted towards your total income or assets.

For the same reason, if you have a mortgage that is being paid via your CPF, you should exclude that amount from your total monthly debt to avoid skewing the ratio.

However, if your mortgage is paid in cash and not via CPF, then you have to add that into your total monthly debt for an accurate picture.

Why you need to know your Debt Asset Ratio

Your debt asset ratio tells you some important things, such as:

• The probability of you getting a loan
• The state of your cashflow
• The likelihood of you being able to retire comfortably

#1 The higher your Debt Asset Ratio, the lower your chances of getting a loan
If you have a high Debt Asset Ratio, it means a large portion of your income is going towards debt repayment.

Which leaves less to cover your other expenses.

Banks and other lenders read this as a risk of you defaulting on your debt repayments. Past a certain threshold, they may simply reject your loan application, as they deem the likelihood of you meeting your debt obligations low.

Therefore, if you’ve been trying and failing to get that renovation loan, try paying off some of your debts first. This will lower your Debt Asset Ratio, and increase your chances of having your loan application approved.

#2 The more you are paying in debt, the weaker your cashflow is
In our example above, we have a Debt Asset Ratio of 30% ($1,200) on a net income of $4,000, leaving only $2,800 to meet our other expenses. You can imagine this doesn’t leave much for other expenses outside of our daily essentials like food, groceries, utilities and insurance.

Forget about starting or building up your emergency fund; that’ll have to wait till some other day, along with important things like investing for the future.

If you should encounter an emergency that costs a couple of thousand bucks, what happens then? You will need to dig into your savings (possibly wiping it out in the process) or have to take out a personal loan, or as a last resort, cover the cost with a credit card.

Now imagine if your Debt Asset Ratio was slashed by half to 15%, leaving you with an extra $600 per month. Your cashflow would be much stronger, and you would be able to start tackling at least some of these crucial financial goals.

#3 The longer your debt asset ratio remains high, the less likely you are able to retire comfortably (unless you’re already rich)
For the average salary person, the economic lifespan is limited to the number of years you can reliably earn an income. So the more of those years you spend with a high debt asset ratio, the less wealth you are able to retain for your own purposes, such as retirement.

Therefore, if your Debt Asset Ratio has been high for a prolonged period, and looks set to remain high, you are risking your ability to retire comfortably (or even at all).

You could check out this article of ours – done in collaboration with CPF – to learn exactly how much you’ll need to retire comfortably according to your choice of lifestyle.

What is a healthy Debt Asset Ratio?

Ideally, your Debt Asset Ratio should be 0%. However, that would also leave no room for necessary and useful loans, which is impractical for those of us who don’t own a diamond mine. Hence, the real world requires a slightly more nuanced approach.

It is important to recognise that not all debt is bad or undesirable. Instead, we need to weigh debt against any potential improvements to our quality of life.

For instance, instead of staying on in the cramped childhood apartment, buying your own property can provide you with a more suitable environment to start your own family. Also, your apartment turns into an asset once you pay up the mortgage.

Similarly, taking that long-awaited Masters can help you attain greater heights in your career, and buying a car can help you earn extra cash as a private-hire driver on the weekends.

All of these scenarios would likely involve taking a loan or a mortgage, and driving up your Debt Asset Ratio in the process. But in return, you’ll reap a host of benefits.

Hence, a healthy Debt Asset Ratio is ideally one that is as low as possible, but as long as you’re able to manage your finances comfortably, don’t be too afraid of taking on a little debt.

Tips for lowering your Debt Asset Ratio

If you’re feeling the pressure from a high Debt Asset Ratio, the solution is straightforward: clear as much of your debt as possible, avoid taking on any more debt, and increase your income.

Here are some tips to help you lower your Debt Asset Ratio.

#1 Consolidate your debt
Use a 0% balance transfer to pay off your outstanding credit card balances, then focus on paying down your balance transfer within the interest-free period. This will help you shorten the period you’re holding on to debt.

If you’re unable to find a suitable balance transfer, try using a personal loan to consolidate your debt instead. Apply for the shortest tenure you can comfortably manage to get out of debt as quickly as possible.

#2 Accelerate your debt repayment
If you have some cash leftover at the end of the month, it may be worthwhile to use it to pay off your debts quicker. Yes, your Debt Asset Ratio will go up while you’re doing this, but you’ll accelerate your repayment timeline. And over time, even $50 extra per month can make a substantial dent in your mountain of debt.

#3 Pay off whatever you can right now
Check for credit cards with low balances or loans with only a few instalments left on them. If you have the cash, pay these off in one lump sum to take a chunk off your Debt Asset Ratio. Be aware you may be charged an early repayment fee for loans, though.

#4 Increase your income
Scrimping and saving can only get you so far. Consider taking up a side gig for increased income that you can put into debt repayment, so you can spare yourself further hardship in the future.

Remember, debt won’t last forever (unless we purposely keep it around), so keep going and your Debt Asset Ratio will start dropping faster than you realise!

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