Debt in Canada: The Ticking Time Bomb

March 1st, 2010 by A Licensed Insolvency Trustee

As we celebrate Team Canada’s men’s and women’s gold medals in hockey at the Vancouver 2010 Olympics, we are all feeling good. Our country is back on top of the hockey world, and things are looking up. While we may be feeling good about our hockey teams, we aren’t feeling as good financially. Why? 2009 was a record year for personal bankruptcy filings in Canada, and the causes of the spike in bankruptcies have not gone away. The economy remains weak, and we are still carrying record levels of personal debt. That’s our biggest financial problem: debt. Debt continues to grow, and, like a ticking time bomb, high debt levels get us closer to the point of no return.

Despite the recession, or perhaps because of it, Canadians continue to borrow at record levels. By the end of the third quarter of 2009 the average Canadian adult had over $40,000 in household credit, a record level. Household credit includes credit cards, bank loans, and mortgages, so $40,000 may not appear to be a large number. After all, many people have mortgages of greater than $40,000. That’s true, but many other Canadians don’t have any mortgages or debt, so to average $40,000 over all adult Canadians, many of us are obviously carrying a significant amount of debt. As the chart shows, back in the year 2000 we each had approximately $20,000 in debt, so in less than a decade the debt we are carrying has doubled.

That’s a staggering statistic. If you are the average Canadian, your debt has doubled. Has your income doubled? Are you making twice as much today as you were earning in the year 2000? Probably not. If you still have a job you may have received “cost of living” increases of 2% per year for the last decade, but that obviously does not add up to a doubling of your income.

With these massive levels of debt, why hasn’t everyone gone bankrupt in Canada? Part of the reason is that interest rates have remained low.

 

In fact, mortgage rates, and consumer loan rates are lower today than they were three years ago. Low rates are partially due to governments around the world deliberately keeping rates low to stimulate spending, but low rates are also the result of the recession, where fewer people are borrowing to buy new houses, cars, and other goods.

Of course debt alone is not a problem. If I have a million dollar mortgage, but I have a job that pays me $2 million per year, my large mortgage is not really a problem. However, even if I have a small $50,000 mortgage, if I’m not working I won’t be able to make my mortgage payments on even a small mortgage. The key here is serviceability: your ability to service the debt you have.

 

Our ability to service our debt is a combination of the amount of debt we have (which is high), the interest rates we are paying (which are low today on most forms of debt), and our income (which for many Canadians has decreased during the recession). As the chart shows, our household debt as a percentage of our personal disposable income continues to rise.

In fact, by the end of the end of September 2009 (the most recent numbers available), the average Canadian adult was carrying household debt of 140.8% of their personal disposable income. That’s the highest level in history. Three years ago that level was “only” 120%. Stated another way, for every dollar you earn, you have $1.41 in debt, if you are the average Canadian. Obviously during this recession our debt has increased much faster than our income, and Canadians are spending more of each dollar they earn servicing their debts.

If you have a good job, and if interest rates stay low, you will probably be able to continue to service your debts. But the numbers prove that we are standing on the edge of a cliff, and all it will take is a slight breeze to knock us over the edge.

Ask yourself this: if you were to lose your job, or have your hours cut back at work, or go through a divorce, or have a medical problem so you couldn’t work, would you be able to continue paying your mortgage, your car loan, your line of credit, and your credit cards? For most people, the answer is “no”.

So what can you do to protect yourself?

First realize that your situation is precarious. Unless you have a very secure job, be very careful taking on new debt. Now may not be the time to buy a bigger house, or a new car.

Second, take steps now to reduce your expenses. You probably don’t control your paycheque, but you can control your expenses. Think about moving to a smaller house or apartment to save money. Trading in your car for something with a lower monthly payment, and a vehicle that’s better on gas, may be a good idea. Review all of your other expenses: do you really need 500 channels on T.V.that you never watch? Do you need to buy your coffee each day at the coffee shop, or can you learn to make your own? If you reduce your expenses, you will have more money to use to pay down your debts.

Finally, take steps to reduce your debt. Sell your second car and pay off the loan. Put a freeze on new spending, and start paying down your debt. Don’t just pay the minimum monthly payment on your credit cards; actively work to pay them off completely. If you can pay off your debts while you are still working, you will be in a much better position to weather the storm if you do get laid off, or if your hours are cut.

If you have already suffered through a job loss, or reduced hours at work, and if you already have more debt than you can service, it’s time to be pro-active and look for ways to eliminate your debt. That may mean you need to consider a consumer proposal or personal bankruptcy in Canada. The numbers prove that our debt problems are getting worse, not better, so there is no better time than the present to take action to reduce our debts.

A Licensed Insolvency Trustee

9 Responses to “Debt in Canada: The Ticking Time Bomb”



November 27, 2010 at 10:58 am, Matt said:

I think this article is a little short sited. First of all it does not identify 3 very important things. #1) What is healthy debt. and #2) What is realistic a realistic Debt for for the majority of Canadians. #3) what is the average net worth of canadians. meaning once you take into consideration savings accounts, RRSP’s, Stock portfolio’s, and other investments, on average what is the net worth of canadians.

I ask these questions not because I know the answer, but because I would expect an article like this to explore these very important facits of this topic. What is a healthy debt ratio? and how do I calculate mine to see if it is healthy. As well what is realistic? the graphs indicate $40,000/per person of debt is high, yet I challenge you to find a house in Tornonto, Calgary, Edmonton, or Vancouver for under $200,000. it is just not possible. and in many cases the number can be as high as $300-400,000. even when we divide that number by 2 income earners that number is still 5x what you consider to be high. so although 40,000 is high in terms of an average, What is Realistic?
I also ask is it possible that because interest rates are so low in canada for mortgages, that many of the older generation that have typically had their mortgages paid are re-mortgaging to invest the money in more profitable enterprises? do they have assets that significantly out weigh this debt.
As well have attitudes in older generations simply changed. Their are not that many people left in canada that weathered the great depression. the attitudes of our grand parents, of saving everything you have on the off chance depression strikes, simply does not exist any more. I also ask is that attitude really healthy for the economy? were the 2001 numbers low to an unhealthy degree? are older people taking out small, “reverse life insurance” mortgates, freeing up a small portionb if their equity in their homes to do the things they want to do in life now. And in doing so is this secure? as long as the majority of the equity is still in the home.

This article points out a lot of facts. But there is little or no information that indicates the reall nitty gritty substance of the situation for canadians. I think mortgages are a good thing. and I don;t feel it is unrealistic for a 2 income family making $60-70k/ year to have a $150-250k mortgage. As housing values go up and the total mortgage goes down eventually this will prove to be a much better investement than moving into an appartement, where after 10 years of having slightly lower payments, all you have to show for it is a shoebox full of rent reciepts, instead of $60-70,000 in equity on a home.



November 29, 2010 at 4:31 am, A Licensed Trustee said:

Your points are valid, but I don’t believe there is a formula to determine what is “healthy debt”.

For example, let’s assume I have a job making $100,000 per year, and I have a $50,000 down payment, so I buy a $200,000 house, with a $150,000 mortgage. Let’s assume that my mortgage payment will be about $800 per month, which is less than I will pay in rent. Is this mortgage “healthy debt”?

If I keep my job, and if house prices increase, than most would agree that this is healthy debt; my wealth will increase because of the leverage I get from owning a house.

However, what happens if I lose my job, and have trouble making the mortgage payments? What happens if I bought my house at the peak of the housing market in many places in Canada in early 2008, and I was forced to sell my house when housing prices were depressed in many areas in 2009 and 2010? If I can only sell my house for $180,000, and with real estate commissions and legal fees I may only net $170,000, which means I have lost $30,000 of my original $50,000 down payment.

In that case it would be hard to argue that the mortgage was “healthy debt”. In hindsight, I would have been better off putting my $50,000 in GICs, and renting.

And that’s the problem with any kind of analysis of “healthy debt”: you need hindsight to know which decision is correct. If you bought a house in 2000, and sold it in 2007, you made a lot of money, so owning and paying a mortgage was obviously better than renting. If you bought a house in 1988, when mortgage interest rates were over 13%, it took until 1995, or later, in many parts of the country for you to break even. During those years renting may have been a better option.

So, my advice is this: if you are taking on debt, for a mortgage, or a car loan, or anything else, ask yourself these questions: “If I lose my job, or if my income is reduced, can I still pay the debt?” “If the house drops in value, am I prepared for the loss?” We don’t know the future, but if you anticipate all possible outcomes, you can be prepared. This analysis may encourage you to buy a slightly smaller house than the maximum house you can afford, or perhaps to rent for an extra year or two to build up a larger down payment, which in the long run may be prudent. For more thoughts on this, you can read my article on why A house is not an investment.



November 30, 2010 at 6:21 pm, Hugo said:

Hello from Vancouver.

I love reading stuff like this…it’s so hilarious. $200,000 house… PFffffft! I nearly shot my coffee out of my nose when I read that. A HOUSE? For two hundred? Is it currently on fire and the land is about to slide off a cliff?

You can’t get a house for less than a million dollars. Everyone knows that.



December 28, 2010 at 1:20 am, Andy said:

All this personal debt is all crap. The government is worried about our personal debt because they know they cant tax us anymore or they will send us into bankruptcy. The government should stfu and stop spending our money and reduce our taxes so maybe we can start earning some money ourselves. I say to Canadians borrow borrow borrow so we can all declare bankruptcy and not worry about our debts. The only one to lose are the billionaires and millionaires and the government because they will not be able to buy fake lakes anymore.



December 28, 2010 at 4:39 pm, Randall said:

Canada is so economically widespread. You can’t just propose an average amount of debt per “Canadian”.
Is this Mean, Mode or Median debt? The house or ‘home’ price range over our 3000km country, is too great to pick one average for Canada. They need to break it up into at least 3 different geographic and economic areas. I would be interested in a more accurate number.



December 28, 2010 at 8:30 pm, Alan said:

Alan

Hello from Calgary
There is a lot of stuff like this currently .The article is interesting and concerning.I would like to add a little information that I think is important .The tactics and intentions of the decision makers in revealing these debt/income ratios is clear. An article written by Deidre McMurdy and was on MSN Money site really took a run at the tactics of the authors of these articles.In a nutshell what she said was” be carefull what you wish for”.If the unanticipated result of the deluge of scary statistics is that you drive the consumer out of the market and into saving mode commerce grinds slowly to a halt.(a bit extreme I admit but definitely creating a slowing trend).The part of her article that really got me stirred up however was a comment that she attributed to Douglas Porter ,chief economist for BMO.He is not as concerned as you might think.The reason is in the debt/income ratio calculation.Typically calculation of net worth excludes capital gains as well as returns on tax sheltered vehicles like RSP’s and TFSA .WHAT!!! How can you trot out a debt/income ratio of 148.1%, apply it to the Canadian population and not include the above sources of income in the calculation. Especially when you consider the demographics of our Canadian population and the number of seniors living off these income sources.I am not advocating a spending spree but I sure would like the decision makers to make all the facts available instead of manipulating the information for their desired outcome. By the way the article I am referring to was written by Deidre McMurdy and was titled “Is there truth in recent debt warnings?


December 28, 2010 at 10:15 pm, Internet Marketing Blog said:

It will be catastrophic once they raise interest rates. Canadians think that they’re safe the media is doing a good job portraying that image but the truth is ALLOT of families are in serious financial trouble, and the one thing Canadians don’t seem to realize is that Canada doesn’t have the luxury printing massive amounts of money because unlike the United States Canada does not have the world’s reserve currency furthermore the Canadian population is about as big as New York State.

The one positive Canada has is that there is an abundance of natural resources that the world currently needs.



February 11, 2011 at 4:42 pm, Geoff said:

So does anybody know how to calculate their own Household debt as a % of DPI? It sucks that all these articles say how high the ratio is but don’t tell you how to calculate your own situation. My understanding is that this ratio is different than the debt-service ratio which I can calculate fine.



February 16, 2011 at 6:36 pm, yup said:

hahaha the comments on this page are hilarious. I’m actually in tears. Hugo’s is funny as hell – said with such confidence but true in it’s own way.

I’m with Andy on the borrow borrow borrow. Ha one day all that weight is gona come crashing down on them. In reality, in my opinion, people don’t really need personal loans. For cars, school and houses sure but for an aquarium and fun toys, it really shouldn’t be accessible the way it is.

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