Calgary by abdallahh

The media has recently informed us that Canadians are raising their household debt (by 6 per cent in the second quarter of 2011), and economists as well as the national central bank are getting concerned about families’ ability to cover their payments if interest rates go up. But how serious is the debt situation in Canada? Do they really have reason to be worried?

Rising Debt Ratios

Canadians’ enthusiasm for borrowing comes from low interest rates, rising home prices, and economic prospects that are among the brightest in the G7. The ratio of household credit debt to disposable income reached 147.3 per cent in the first quarter of 2011 and 148.7 per cent in the second quarter, according to Statistics Canada. That’s the highest level since the agency began keeping these figures in 1990. The ratio measuring household debt to income rose from 149.5 per cent to 150.8 per cent in the second quarter.

“We are concerned that Canadian consumers are relying on low interest rates to support high debt loads,” Moody’s rating agency said in its report. “The creditworthiness of Canadian banks depends on the continued financial health of the Canadian consumer. While robust growth in consumer credit has driven strong systemwide earnings year-to-date, this trend will be constrained as households reach borrowing limits at the same time the economy shows few signs of anything beyond tepid growth.”

Measure Twice; Cut Once

Canadian Bankers Association logo
by Wikimedia Commons

The situation is the expected consequence of the financial crisis. Interest rates are low, so borrowing is then more attractive, and naturally, the number of debtors gets higher although their income grows at the same pace. However, the number of mortgage arrears is still below the ‘90s levels according to data by the Canadian Bankers’ Association. Canada’s banks still follow their strict borrowing rules, which have been one of the reasons for the World Economic Forum’s decision to rank Canada’s banking system as the world’s soundest. High debt isn’t a problem when debtors are able to meet their obligations, so now the debt situation isn’t so worrying.

David Onyett-Jeffries, an economist at the Royal Bank of Canada, also objected that there is a difference in that the buildup of debt in Canada has been gradual over the years, unlike that in the U.S., where there was a sharp run-up prior to 2007 followed by severe de-leveraging.

“People make a big deal of the fact that Canada has a bigger debt-to-income measure,” Mr. Onyett-Jeffries said. “We’re not of the mindset that it’s a perilous position.”

Taking out a loan is a big decision, as it is a long-term liability that will be repaid after years, and it is impossible to predict (exactly) how our financial situation might change. That’s why warnings about increasing debt are required anyway; they force consumers to consider carefully whether to borrow and may discourage those who aren’t sure whether they will be able to pay instalments after interest rates change or unemployment grows. Otherwise, Canada’s debt would seriously hurt its economy after it put pressure on interest rates.