Canadian Personal Debt A Cause for Concern
November 8th, 2010 by Barton Goth, Trustee
TD Economics released a report on Wednesday October 20, 2010 titled Canadian Household Debt a Cause for Concern that tried to answer many questions currently plaguing the Canadian consumer and the economy in general, including whether or not Canada is headed for a U.S.-style household debt crisis.
Some of the key findings that were outlined were as follows:
1. Since the mid-1980s, total household debt as a share of personal disposable income in Canada has almost tripled – from 50% to 146%
2. Statistics demonstrate a rapid convergence in the Canadian household debt-to-income ratio similar to that of the United States.
3. At 146% of after-tax income, Canadian personal indebtedness has become excessive.
4. Economic and financial fundamentals suggest that the personal debt-to-income ratio should be in the range of 138% to 140%.
5. The past rapid growth in household indebtedness has been fuelled by both many factors, including lower borrowing costs, greater household confidence, stable inflation, relatively stable growth in the economy and labor market, increasing demand for credit, increased labor market participation by women, and a greater desire to consumer larger quantities of discretionary items.
6. Some Canadian households have become too leveraged and estimated that perhaps 10-11% of households could experience financial stress when interest rates rise in the future.
While the report’s findings appear somewhat bleak, the good news is that overall they concluded that “The Canadian debt imbalance is currently not as great as that experienced in the U.S.” They continue to say that at some point, when our current interest rates return to historically normal levels, the interest rate change will create financial stress on some Canadian households, but definitely not the majority. But this “relentless” rise of household debt in Canada is a growing cause for concern.
Is this new information? Absolutely not, one of the most cited risks to the Canadian economy is the indebtedness of the average Canadian. Is this the full story? Likely not. It is important to remember that statistics are often subjective and these statistics were designed to emphasize the negative, and I find the situation is typically not quite as bleak as is reported by the media.
However, the recent TD study identified a few positive things. For example, TD predicts that we are not on the verge of a collapse similar to what the US has suffered and demonstrated that the level of personal disposable income is still less than where the US was when everything collapsed. The key is that the average Canadian consumer has to recognize that the biggest threats to our finances, and in turn to the economy at large, are continued reliance on credit and the likelihood of future interest rate increases. The good news is we still have a time to insulate ourselves from these threats. As Canadians what we all need to take 3 steps.
1. Take Stock
2. Reduce our reliance on credit
3. Develop a plan to pay down our debt.
If you don’t already know where you sit financially it is time to find out. Begin by taking stock of your current financial circumstances. Compile a list of who you owe, approximately how much, the interest you are paying and your minimum monthly payment. Once you have done this, make note of your monthly net income and all your monthly expenses. How are you doing? Do you have enough to pay more than the minimum on each of your debts? If so, great! You are well on your way. If not, examine your expenses, establish priorities, and find a way to make things work. If your debts are too high you may have to consider the filing of a consumer proposal, a debt management plan , or potentially even a bankruptcy, depending on how severe things are. But you first need to find a way to make things work on paper.
Second, it is time to realize that credit costs. Remember, every time you use somebody else’s money, there is a cost. Sure it is nice to be able to buy anything at any time without worrying about how much cash we have in the bank. But is a sale really as good as it appears when we know we are going to have to pay 20% interest on that purchase? How many of the items that we buy on credit are truly essential? If you are going to reduce your family’s exposure to the looming interest rate increases that are inevitable, you need to move away from a credit-based lifestyle and focus on a cash-based one. After all, cash is always the cheapest way to manage your finances. It reduces the interest we pay, often forces us to consider our purchases a little more, and ultimately leads to a much healthier balance sheet. This is really a matter of discipline. Never allow yourself to purchase unnecessary items on credit. Try to only use debt to finance things that will have value at the end of the loan (i.e. car, house etc.). If this sounds difficult, then do yourself a favor by reducing the temptation. Try not carrying credit cards, detaching your line of credit from your bank card, or canceling your overdraft. Put hurdles between you and the access to credit on a daily basis. By making it more difficult to access credit, you will find that you will automatically use less credit.
Finally, it is not just enough to reduce your reliance on credit, you need a plan to pay down your debt. You will need to look at your budget and develop a strategy to reduce your debt. This may begin by consolidating your high interest debt so you can pay less interest and be out of debt quicker, or you may be able to simply by making larger payments to your debts with higher interest rates, and as each debt is paid, reallocate those debt payments to your next most expensive debt. For some you may need to consider formal avenues such as consumer proposal, a debt management plan, or a bankruptcy. Regardless of the method, your quickest way back to financial health and reduced exposure to the risk of interest rate changes, is to make a concentrated effort to pay down your existing debt.
By taking stock, reducing your reliance on credit and developing a plan to pay down your debts, you will be surprised how quickly you are able to improve the state of your finances and insulate your family from any potential difficulties down the road, whether this is increased interest rates, lapses in employment, or temporary health issues. The best advice is always to reduce your reliance on debt.
About the Author: This article has been written by Barton K. Goth of Goth & Company Inc., a licensed Edmonton bankruptcy trustee, member of the Canadian Association of Insolvency and Restructuring Professionals, and a managing editor of the Trustee Talks blog.