Every month we read and hear more concerns expressed about our ever-increasing level of household debt relative to disposable income. Judging by all the hand-wringing on this issue, one would think that Canadians are addicted to spending, and to increasing their debt. Have we really run amok? Should we be seriously concerned?
Obviously, any time that debt levels increase we should not be complacent. When we are younger, in our 20s to 50s, debt is a necessary evil — ideally to be wrestled down as quickly as possible. By the time we are ready to retire however, debt should be considered the worst enemy of a comfortable retirement. Achieving zero debt as soon as possible should be a major priority of all Canadians.
So yes, we should not be complacent about debt levels. On the other hand, before we conclude that a dangerous debt bubble is brewing, we must look at all the facts impacting the debt of Canadians.
The most recent numbers from Statistics Canada show that for every dollar of disposable household income, the average family carries $1.63 of debt — for a debt-to-disposable-income ratio of 163.3%.
Compared to the 1990 ratio of 85.3%, this is almost double that of 25 years ago. Today however, and for many recent years, interest rates have been at less than half those which existed in 1990.
Today, with more than twice the debt-service capacity, compared to 25 years ago, simple mathematics shows that despite the doubling of our debt burden, we are able on average, to cope with today’s debt as easily as in 1990. Currently the average family interest burden amounts to about 6.8% of disposable income — the lowest level recorded since 1990. Indeed, delinquency rates seem to bear this out. On both mortgage and credit card debt, we are near all-time delinquency lows of less than 0.3%.
It is also noteworthy that today’s average Canadian family has a net worth that is about 4.5 times the amount of their total debt — a healthy cushion.
The real problem of course, is that these comforting statistics deal only with averages, thus disguising the fact that about a quarter of Canadians carry zero debt, while another quarter have debts of less than $50,000. This means that other families carry huge debts, far above the average numbers released each month. It is this segment of our population which must carefully weigh the risks of adding to their debt.
Fortunately, more than 70% of household debt is in mortgages. If today’s new homeowner purchases a home with an available 2.79% 5-year fixed interest rate, he enjoys a number of buffer years in which family earnings can grow to deal with rate increases on a future mortgage renewal.
Despite all the negative publicity, Canada is not facing a debt crisis — at today’s interest rates.
Should the rates suddenly spike however, the picture could quickly change. For that reason, the Bank of Canada and others will continue to express concern about debt levels. Theirs is an early-warning signal to the minority of families who may be stretched to their debt-service limit. To that group of families, the cautions are most appropriate.
Realistically, neither the Bank of Canada, nor the U.S. Federal Reserve, can ignore the fact that substantial or frequent increases in interest rates would present a major risk to their respective economies.
Should such occur, home prices would plummet, debt-service delinquencies would spike, and unemployment would rise sharply. In any Central Bank’s deliberations, this concern is bound to have a major influence on the pace and magnitude of future rate increases.
Yes, interest rates can only go up. But they are very likely to be modest in scope and slow in their pace, allowing families to gradually accommodate the impact.
Entering into any new debt should be done with eyes wide open to the longer-term risk that rising interest rates would represent.
However, as a nation, we have not spun out-of-control on either our spending or our level of debt.
A retired corporate executive, enjoying post-retirement as an independent Financial Consultant (www.dolezalconsultants.ca), Peter Dolezal is the author of three books, including his most recent, The SMART CANADIAN WEALTH-BUILDER.