Formula No. 2: Find leverage ratio using income
The term "leverage" means the use of borrowed capital -- debt. Most people use leverage to buy a house -- that's why you have a mortgage. So, leverage in and of itself isn't a bad thing. It's when your debt is too great in proportion to your income where you can get into trouble.
Here, you need to compare similar time frames, so if you're looking at your monthly debt payments, you need to use your monthly income as the divisor. A common rule of thumb says that your leverage ratio (including mortgage, car loans, etc.) should be no more than 33 percent of your income.
Stephen Lovell, president of Lovell Wealth Legacy, a registered investment adviser, says the leverage ratio is also useful in determining your coverage ratio; that is to say, how many times you can cover your debt per month. For example, if your total debt payment per month is $1,000 and your monthly income is $4,000, then that's a good ratio -- you have 4 times the coverage.
"If you took a financial hit (such as unemployment or disability), you could continue to pay the mortgage," he says.