That Canada is a country of borrowers, not savers, is now a given. Accumulating high levels of household debt has become a necessity for a modern life – and arguably, a new normal.
Currently, Canadians owe $1.69 for every dollar of after-tax income we earn a year. That ratio is down slightly from $1.70 last year and substantially higher than $1.00 from 20 years ago.
In fact, the amount of debt held by Canadian households has been steadily rising for about 30 years. At the end of 2017, Canadian households owed just over $2 trillion, with mortgages accounting for almost three-quarters of this debt.
According to data from Statistics Canada, 71 per cent of all Canadian families carried some form of debt in 2012 (the most recent data available), up from 67 per cent in 1999. Median debt held in 2012 was $60,100 compared to $36,700 in 1999. That number includes mortgages, as well as money to purchase cars, pay for education, new kitchens and many of the basics Canadians consider the staples of modern middle-class life.
In fact, households with at least $100,000 or more in total income account for 37 per cent of all debt in Canada, according to Statistics Canada. Those with income of at least $50,000 but less than $100,000 represent 38 per cent.
In other words, the vast majority of this debt is owed mostly by middle and upper earners, professionals with university degrees, living in thriving economic regions like British Columbia, Alberta and Ontario and earning at least $100,000 a year.
The normalization of debt
Clearly, debt has achieved unprecedented approbation in this country. Debt has not only lost its stigma, it is now culturally more acceptable in Canada than ever before. Canadians are socialized into debt at an earlier age as younger people are developing an awareness of it by necessity and appear to be living with it longer. Our parents and grandparents borrowed to buy houses and cars with the intention of paying it back. Not many think that way anymore because of the changing marketplace in which we today live.
Bank of Canada Governor Stephen Poloz acknowledged as much in a speech in May, when he remarked that “Today’s record level of household borrowing reflects the evolution of the financial system and the comfort level of Canadians in taking on debt.” Now, with interest rates on the rise, signs of a reckoning in the form of household financial stress may start manifesting.
Indeed, a closer examination of the numbers suggest serious risks to the economy are real possibilities, and the fallout could be far-reaching. Consider the $1.69 figure represents an average across Canadian households – those with little or no debt and those at the other extreme. According to the Bank of Canada, about eight per cent of indebted households owe a staggering 350 per cent or more of their gross income. Another 35 per cent of Canadian families were carrying debt worth at least two times the value of their after-tax annual income, as of 2012 according to Statistics Canada. Only one-third of Canadian households carried debt that did not total more than 50 per cent of their after-tax family income.
Let’s dispense with the obvious: the more debt you have, the more vulnerable you are and hence, the more you will be affected by an increase in interest rates. As rates rise, expect debt loads will multiply as the cost to service the debt soars. Conversely, those carrying less debt may be at less risk of financial shock since they have less exposure.
On the positive side, rising interest rates tend to restrain debt accumulation. On the other hand, they also threaten the ability of those who are over-leveraged to manage their debt service costs. Based on the demographics of the data, the most fragile household balance sheets in the country – and those potentially in line to suffer the most misery – belong to the wide swath known as the middle class. These Canadians are lower- to middle-class individuals and two-income families earning between $40,000 to $100,000 according to Statistics Canada.
For now, some experts say there doesn’t appear to be any clear, discernible signs of stress in Canadians’ ability to service the record debt loads. According to a Royal Bank of Canada report on household debt released in June, 2018, Canadians piled up less household debt in the first quarter of 2018, in part because disposable income rose five per cent — the fastest annual rate in nine years. At the same time, RBC found interest rate payments increased 10.5 per cent in the first quarter of 2018 while growth in principal payments slowed.
“All in all, total debt service payments are on an accelerating path,” RBC noted in its report. “The bottom line: rapidly increasing interest payments aren’t yet intensifying financial pressure for Canadian households, overall.”
Still, there are potential warning signs. Equifax Canada, the country’s largest credit reporting firm, predicts that delinquency rates for credit cards (which measure payments of non-mortgage debt more than 90 days past due) will climb this year. Already, the number of Canadians paying off their cards in full each month in the first half of 2018 declined to 56 per cent from 59 per cent last year, according to Equifax.
At the same time, some major banks are reporting that the roll rate, which is the percentage of credit card holders who move from early stage delinquency to 60 days to 89 days, is at its highest levels since 2008.
The world of easy money helped transform Canada into debt nation by making it comfortable to live in arrears. Now, the question is how agreeable Canadians will be when that marketplace inevitably changes.