Wrestle down that debt while you can

Share

Snug and smug we Canadians are as we borrow and spend our way into the new year.

But the dream is almost over. A financial squeeze is coming in the next year or so and the risks are serious enough that Bank of Canada Governor Mark Carney has twice warned about them in the past seven days.

Despite a recession, we've borrowed our way to record debt levels this year. As Mr. Carney said Wednesday, rising interest rates are going to make it increasingly hard to manage this debt. What he didn't say is that high unemployment, government cutbacks and potential tax increases will make it even tougher for borrowers.

To start with, there's the impact of the deficits that Ottawa and the provinces have racked up fighting the recession and global financial crisis. Prepare for a future of paying more and getting less from government.

Toronto-Dominion Bank chief economist Don Drummond figures that the federal government can get back to a balanced budget by 2015 from the projected current year shortfall of $56.2-billion by leaving taxes alone and limiting spending increases.

But in an opinion piece published in The Globe earlier this week, Peter DeVries and Scott Clark (both of whom worked with Mr. Drummond in the federal finance department in the 1990s) wrote that "any credible budget will have to include tax increases." They raised the idea of returning the GST to 7 per cent from 5 per cent, and boosting the high income tax rate.

Mr. Drummond himself suggests that the provinces will have to look at tax increases to boost revenue. "It would be darn hard, but not impossible, to get back to a balanced budget as soon as 2015, without touching the revenue side."

The uproar in Ontario over the harmonized sales tax coming next July shows how closed off Canadians are to higher taxes.

"Citizens are demanding greater public services related to health care, the environment, old age and the like, while at the same time resolutely refusing to pay higher taxes for these services," Peter Bethlenfalvy co-president of DBRS Ltd., says in a speech he's been delivering across the country lately.

Health care is an area to keep an eye on. DBRS says that health care costs represent 30 to 40 per cent of provincial budgets, and that costs are rising at a rate of 5 to 7 per cent annually. "Down the road, governments are going to have to make tough choices," Mr. Bethlenfalvy said in an interview.

Choice one for governments: raise taxes. Choice two: cut services, which means costs are downloaded to users of the health care system. Either way, you end up paying more.

Rising interest rates are the risk that the Bank of Canada's Mr. Carney has been focusing on. Experts disagree about when the rates that influence consumer borrowing costs will rise meaningfully, but it could be in the second half of next year or in early 2011.

Higher rates are great news for seniors and others looking for a safe source of income. But for the people who have been driving up their household debt levels even through the recession, higher rates are dead weight. This is all the more true for people who are buying into a red-hot housing market, where prices have surged past their pre-recession peak.

Here's what you're doing if you buy a house now.

First, you're paying top dollar and running the risk of a price pullback that could range from mild to severe. Secondly, you're borrowing at low rates that are likely to either float higher if you have a variable-rate mortgage or jump considerably when renewing a fixed-rate mortgage.

Hoping for income growth to grease your way through this squeeze? Good luck with that in the aftermath of recession where unemployment is stubborn and companies are in a cost-cutting frame of mind.

People curtailed their borrowing in past recessions, but not this time around. "This is the only recession where credit continued to expand, and it grew by 7 per cent [year over year] which is strong," said economist Benjamin Tal of CIBC World Markets.

The Bank of Canada made it inviting to borrow by cutting interest rates to juice the economy. Now, it's up to Canadians to be adults about all the cheap money available. There are lots of reasons why the money borrowed today - for houses or anything else - could be harder than you imagine to pay back later.

So enjoy the rising stock market, the strong housing market and those tasty low interest rates, but don't get complacent. A financial squeeze is coming and you need to prepare.

Follow me on Facebook. I'm at Rob Carrick - Personal Finance.