Since the 1980’s, household debt as a share of personal disposable income has almost tripled in Canada, rising from 50 per cent to 146 per cent in 2010. Many organizations, including the Bank of Canada, have expressed concern about the potential consequences of Canadians’ rising debt.
There are several circumstances that have contributed to this increased debt level. First, the increased participation of woman in the labour market created a greater number of double-income households, which contributed to a greater sense of income security and a willingness to carry more debt than single-income households.
In addition, in the early 1990’s, the Bank of Canada introduced a policy that targeted inflation by keeping interest rates low, thus improving debt affordability. Stable inflation reduced the risk of future interest rate volatility, while stable growth in the economy reduced the probability of layoffs; these factors allowed more people to comfortably carry more debt.
Not surprisingly, real estate has also contributed significantly to Canadians’ debt. Over the past 20 years, mortgage lending rules have eased; minimum down payments were reduced from 10 per cent to 5 per cent, and the maximum amortization was increased from 25 years to 40 years, but has subsequently been reduced to 35 years. Relaxing the mortgage lending rules made debt easier to qualify for, and home equity lines of credit allowed households to extract equity from their home for consumption or investment purposes, while offering flexible repayment terms.
Over the past decade, these changes led to steadily increasing home ownership rates, which created greater confidence in the housing market and increased the demand for houses. As a result, the average price of real estate rose across Canada, which, when combined with rising equity markets, created a positive wealth effect, that in turn encouraged further borrowing.
There has also been a cultural shift, as Canada changed from a culture of thrift to a culture of consumerism. This change was driven largely by the baby boom generation (those born between 1946 and1964), who, unlike their parents, did not have their spending tempered by experiencing the Great Depression. As a result, individuals took on debt earlier and maintained debt longer, often into retirement.
While people may be used to cheap credit, the rise in debt is largely unsustainable and will likely be tempered by: increased interest rates; a correction in the Canadian real estate market and reduced home equity; baby boomers exiting their peak consumption years; and increased lending criteria by financial institutions, as they perceive the credit risk rising. The Canadian economy is also likely entering a period of moderate growth, which will cap significant wage growth.
While interest rates are not expected to rise significantly in the near future, it is hoped that the market will gradually correct and lead to an overall, balanced decline in Canadians’ debt.
Rob Radloff is a chartered accountant with The Covenant Planning Group Inc., a Family Wealth Advisor. Investment services are provided by Covenant Capital Management Inc.