Canadians are showing they can pile on the debt with the best in the world – and they're not doing it simply to afford their homes.
The average Canadian's non-mortgage debt reached $26,221 in the second quarter, according to a report Thursday from TransUnion, the highest level since the credit bureau started tracking the data in 2004.
The jump in debt, which was 2.4-per-cent higher than a year ago, was caused in large part by borrowing to buy vehicles. TransUnion said its survey found "auto borrower debt" was up 13.2 per cent, year over year. Credit card balances and lines of credit were essentially flat. The survey is another sign that low interest rates are encouraging Canadians to borrow, despite repeated warnings by Bank of Canada Governor Mark Carney that consumers should curb their appetite for debt.
But Mr. Carney and other policy makers have a tricky job: They need to persuade Canadians to stay out of debt trouble, without scaring consumers into quitting the borrowing habit altogether, and hurting the economy.
Over the past decade, Canadian households dug themselves into a financial hole of $50-billion a year as they took on mortgage, credit card and other debts, reversing years of surplus. Credit-fuelled spending has largely sustained the economy as Canadians bought homes and filled them with everything from new light fixtures to flat-screen TVs.
After leveraging up, Canadians are expected to begin leveraging down over the next couple of years as the housing market cools and interest rates return to more normal levels.
That means other sectors of the economy will have to make up the gap, or the country could wind up in a heap of trouble.
"Even though desirable, eliminating the household sector's net financial deficit will eventually leave a noticeable $50-billion gap in our economy over two years," Mr. Carney warned this week. Businesses will have to make up the slack by investing more and boosting exports or the economy will struggle, he suggested.
Bank of Montreal economist Michael Gregory likened Canada's household debt dilemma to the challenge facing someone who's overweight. They could simply stop eating, but then they would get sick, he pointed out. The ideal solution is for people to eat – and borrow – less.
"We really don't want to be in a situation where you actually have net deleveraging. That is never a friendly thing for an economy, and we don't have a heck of a lot of momentum in the economy right now," Mr. Gregory explained. "What you want to see is credit growth slow below rates of income. That way you get the best of all worlds."
Right now, Canadians are continuing to take on debt at a faster rate than incomes are growing. Canadian disposable income grew at an annual rate of 2.3 per cent in May, according to Bank of Canada figures. But households are taking on debt at an even faster clip – 5.7 per cent – including mortgage debt (up 7 per cent) and consumer debt (up 2.6 per cent).
Measured as a percentage of GDP, household debt is at a record high of 150 per cent, and rising. That's higher than the rate for Americans, Australians and people in most other rich countries. And it comes in spite of warnings and a string of policy changes to rein in mortgage debt.
Canadians may be taking their cue from experts, who don't expect interest rates to rise for a year or more, said Thomas Higgins, TransUnion's vice-president of analytics. "Maybe people are thinking that they don't need to tighten their borrowing too much, that they have a bit of leeway," he said.
The tipping point will come when interest rate begin to rise, putting a squeeze on borrowers.
Worried about the trend, the Bank of Canada has developed complex micro-simulation models to "stress test" vulnerable Canadian households, and the banks that lend them money. In a speech Tuesday in Kingston, deputy governor Agathe Cote said those models suggest the share of "highly indebted" households would rise to 10 per cent in 2016 from 6 per cent in 2011 if interest rates reach 4.25 per cent. The bank defines "heavily indebted" as households that spend at least 40 per cent of their income on debt service charges.