No more shrill warnings about the dangers of high household debt levels. I’m moving on.
Don’t freak – the personal finance law that debt is bad has not been repealed. Debt makes you vulnerable to a drop in income or job loss, and it may prevent you from saving enough for retirement. Reducing the amount you owe is a good thing to do, period.
But today’s high debt loads are not as dangerous as once thought. We need a more nuanced discussion on debt than just shouting at people about how bad it is.
Part of the change in thinking on debt reflects a sense that we are returning to a more normal economy after five years of confusion and disruption. Things that seemed almost apocalyptic a few years ago now seem liveable, if not desirable.
The case for not worrying quite so much about debt was laid out by the chief economist at CIBC World Markets earlier this week in a note issued with the headline: Debt is Not a Four-Letter Word. “There’s no reason to raise alarm bells over household debt,” Avery Shenfeld wrote.
The most-often quoted gauge of Canada’s indebtedness is our average debt-to-income ratio, which hit 164 per cent as of the end of last year. Mr. Shenfeld said that’s high compared with U.S. levels both now and in 2006, before the housing market crashed. Still, he thinks debt levels in this country are not a big worry.
One reason is that debt in Canada is generally held by people who can afford to pay if off. “The problem in the U.S. was that too much debt was issued to people who couldn’t afford it,” Mr. Shenfeld said.
The affordability of debt in Canada can be seen in the fact that delinquency rates on lines of credit, loans and credit cards have been low and falling. The number of mortgages in either default or arrears (payments missed for more than three months) has also been heading lower. We may be carrying large debts on average in Canada, but we’re paying them off with ease for the most part.
That’s certainly the story told by the country’s debt-service ratio, which measures how much of our disposable income goes toward interest on mortgages, credit lines and other debts. Statistics Canada says the debt-service ratio in the fourth quarter of last year was 7.1 per cent, the lowest level since records started being kept in 1990.
Historically low interest rates are the reason why debt’s so affordable. Stern warnings about debt – I’ve written my share – typically focus on what might happen when rates return to normal levels. But now it’s looking like this won’t happen for quite a long while.
Bank of Canada Governor Stephen Poloz has talked recently about how the country’s aging population could result in slower economic growth and lower interest rates than we saw pre-crisis. Mr. Shenfeld believes that when the central bank does raise rates, it will move cautiously. “The Bank of Canada knows that households have more debt than they did in previous economic cycles, and thus it will be more careful on the upcoming pace of interest rate hikes.”
Don’t get complacent about debt, though. For one thing, it will be a huge burden if your income falls as a result of changes in your work.
Reduced income is the top reason people cite for their financial problems when they visit Toronto-based Consolidated Credit Counseling Services of Canada, according to executive director Jeffrey Schwartz. “In many cases, it’s people who were employed at one point, lost their jobs and are now re-employed but not earning at the rates that they were before,” Mr. Schwartz said.
Last week’s unemployment report highlights the lack of job security in today’s economy. A total of 28,900 jobs were lost in April and, longer term, there’s been more growth in part-time work than full-time positions.
Another risk posed by high debt loads is that people won’t be able to save enough for retirement. CIBC’s Mr. Shenfeld said he’s particularly concerned about people in their 20s, 30s and 40s who are carrying big mortgages and thus don’t have the cash to save as much as the previous generation. “When they reach 65, they may not be in as good a position as their parents were at the same age.”
The less debt you have, the stronger you are financially. Let’s can the shrill warnings about debt and leave it at that.
Globe app users please click here for chart showing debt-service ratio vs. debt to disposable income ratio