Household debt numbers are staggering, yet Canadians continue to pile it on lured by super-low interest rates.
But do consumers appreciate the true cost of borrowing? Not always, according to Adrian Mastracci, portfolio manager with KCM Wealth Management Inc. in Vancouver.
“We see a lot of people saying, ‘Oh my God. These rates. They are just giving them away.’ And they are – practically,” he explained, “But it is very easy to get yourself into thinking, I can afford this no problem not realizing that one day the piper is going to come knocking at the door and you’re going to have to pay a heck of a lot more.”
Taking on mortgage debt, which accounts for 69 per cent of total household credit, is particularly tantalizing right now as many big banks are offering 2.99-per-cent fixed-rate mortgages, the lowest ever.
Meanwhile, for the 11th consecutive time, the Bank of Canada left its key interest rate at 1 per cent, which marks the longest pause in rate hikes since the mid-1990s.
But at the same time, Federal Finance Minister Jim Flaherty and Bank of Canada Governor Mark Carney have been warning Canadians about taking on too much debt. Still, expectations are that household debt, loaded on by mortgages, credit cards, lines of credit and car loans, will continue to rise even though it is already at record levels.
In the third quarter, the debt-to-income ratio soared to 152.98 per cent, according to Statistics Canada. It’s been steadily marching toward the 160-per-cent barrier, a level that triggered trouble for the United States and the United Kingdom a few years ago.
“You still have to earn money, pay tax, and have enough money after tax to pay your loan, whatever it is, in whatever [tax]bracket you’re in,” Mr. Mastracci said.
Consider the implications of a non-deductible 5-per-cent loan.
For borrowers in the 35-per-cent tax bracket, consumers would need to earn 7.7 per cent to pay income taxes and still have 5 per cent left to cover the loan interest. For those in the 25-per-cent tax bracket, it would require 6.7 per cent earnings, while those in the 45-per-cent bracket, earnings would have to ring in at 9.1 per cent.
But what about those ultra-low mortgages?
“Don’t get lulled into saying 'this is really cheap,' ” Mr. Mastracci said, “It isn’t. Even at 3 per cent, you still have to earn 4.6 per cent – or thereabouts – in order to pay that 3 per cent after you pay the tax.”
Here are some borrowing tips:
- don’t borrow more than you need, repay what you can fast and use any savings from getting a low rate to repay loans
- shop around, negotiate and don’t take no for an answer
- select the shortest amortization and most frequent payback you can afford
- place emergency funds in an institution that you don’t owe money
Mr. Mastracci, who expects interest rates to start climbing in a year or so as the economy improves, noted that loans are the biggest impediment to retirement.
“The more debt you take on, the harder is to get out from under and ultimately save for retirement,” he said, “Just make sure you can afford it, that your cash flow can stand it."