How to Calculate a Leverage Ratio
A leverage ratio equals total assets divided by equity, and its reciprocal, equity ÷ assets, is the fall in asset value that wipes the equity out completely.
The Leverage Ratio formula
Calculator
Enter assets, equity and an asset price fall to get the leverage ratio and how much of the equity that fall destroys.
Everything held, at market value, however it was paid for.
Assets minus borrowed funds. This is the cushion that takes losses first.
How far the assets drop in price. Try the wipeout threshold below.
Every dollar of equity is holding up $16 of assets, so the ratio is 16 to 1.
- Borrowed funds
- $375,000
- Fall in asset value that wipes out equity
- 6.25%
- Loss at the fall you entered
- $16,000
- Equity left after that fall
- $9,000
- Share of equity lost
- 64%
Assets minus equity leaves $375,000 of other people's money funding the position.
Equity is 6.25% of assets, so a drop of that size leaves nothing behind it and the position is insolvent.
That price fall costs $16,000 on the asset side, before any of it reaches the owner.
$9,000 of the owner's money survives, so lenders are still covered.
A 4% move in the assets takes 64% of the equity, because leverage multiplies the loss on its way to the owner.
How to calculate Leverage Ratio, step by step
- 1Take total assets. Everything the bank or investor holds, valued at market prices, whether it was bought with borrowed money or not.
- 2Take equity. Assets minus what was borrowed. Equity is the owner's own money, and it absorbs losses before any lender does.
- 3Divide assets by equity. The result says how many dollars of assets each dollar of equity is holding up. Higher means thinner cover.
- 4Invert the ratio for the wipeout threshold. Equity ÷ assets is the percentage fall in asset value that leaves equity at zero, which is the point of insolvency.
- 5Multiply any asset loss by the ratio. A one percent fall in asset value costs the owner the leverage ratio in percent of equity, which is how leverage magnifies gains and losses alike.
Worked example: Leverage Ratio
An investor holds $400,000 of mortgage-backed securities funded with $25,000 of their own money and $375,000 borrowed. The leverage ratio is 400,000 ÷ 25,000 = 16, so every dollar of equity is carrying $16 of assets. Equity is 25,000 ÷ 400,000 = 6.25% of assets, so a 6.25% fall in the securities wipes the equity out entirely. Even a 4% fall costs 400,000 × 0.04 = $16,000, which is 64% of the equity and leaves $9,000. The loss on the assets reaches the owner multiplied by 16.
Leverage Ratio questions
What does a leverage ratio of 16 mean?
It means the position holds $16 of assets for every $1 of the owner's own money, with the other $15 borrowed. Gains and losses are both measured against that $1, so a 1% move in the assets is a 16% move in the owner's equity. That multiplier is what turns a modest price change into a solvency question.
What is the difference between the leverage ratio and the debt-to-equity ratio?
The leverage ratio divides assets by equity, while the debt-to-equity ratio divides borrowed money by equity. Since assets equal debt plus equity, the two differ by exactly 1, so a leverage ratio of 16 is a debt-to-equity ratio of 15. They rank positions identically, and the choice between them is a matter of convention.
Why does leverage make a small price fall dangerous?
Equity is the cushion that absorbs losses first, and the higher the leverage the thinner that cushion is next to the assets it supports. Once the fall in asset value passes equity ÷ assets, the position owes more than it holds and lenders have a reason to pull their funding immediately. Forced selling into a falling market then drives prices down further for everyone holding the same assets.
Does more leverage always mean more risk?
More leverage always magnifies whatever the assets do, but how dangerous that is depends on how much those assets move. A high ratio against assets whose price barely budges can be safer than a low ratio against volatile ones. Risk is the multiplier combined with the volatility it is applied to, not the ratio on its own.
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