The parliamentary budget watchdog is raising fresh concerns about indebted consumers, warning that household debt will hit a record this year and make it increasingly difficult for Canadians to cope with a slowing economy.
In an analysis examining the economic risks of rising household debt, the Parliamentary Budget Officer predicts that the debt-to-income ratio will hit its highest level since 1990, reaching 174 per cent later this year, up from 171 per cent at the end of last year, driven mainly by a continued rise in home prices.
That will leave Canadian households "increasingly vulnerable to negative shocks," such as rising interest rates or a drop in income, the PBO warned, and will also have implications for the country's major financial institutions that have funded those debts.
The debt-service ratio, a key measure of financial vulnerability that gauges how much income Canadians must pay toward both principal and interest on their debts, will rise to 15.9 per cent from 14.1 per cent over the next five years, the PBO predicts.
That will leave Canadians increasingly stretched to make their debt payments and raise questions about whether the struggling economy can continue to depend on consumer spending to fuel growth.
"Concerns about financial vulnerability are also particularly prominent in the current context, given the recent economic weakness and the expectation that interest rates will rise in the coming years from their historically low levels," PBO staffers Duncan MacDonald and Chris Matier wrote in a report for government watchdog Jean-Denis Fréchette.
The debt-to-income ratio will gradually fall back by to 169 per cent by the end of 2020 as rising interest rates and slowing growth of home prices cause Canadians to curb their appetite for debt, the PBO predicts.
Canada has experienced the largest run-up in household debt of any other Group of Seven country, with Canadians owing more than $171 for every $100 of after-tax income in the third quarter of last year. That figure has nearly doubled since 1990, when Canadians owed $90 for every $100 worth of income.
Household debt has increased at an average annualized rate of 7 per cent in every quarter since 1991, hitting $1.9-trillion in the third quarter of last year, the PBO wrote. From 2000 to 2014, Canada's debt-to-income ratio grew by 56 percentage points, compared with 13 percentage points for other G7 countries.
Household wealth has also risen in value, with assets rising from $2.2-trillion to $11.3-trillion by the end of last year.
Much of the increase came from rising home values, along with an increase in financial assets. Yet the PBO warned that Canadians are more leveraged than in the past, taking on larger mortgages and other loans to pay for those assets.
Even as Canadian households are spending less than ever on interest payments, the rising cost of paying down the principal on loans has more than offset the drop in interest rates. That has kept the debt-service ratio stable since the global financial crisis.
The PBO predicts that the Bank of Canada will eventually begin to raise its key interest rate from 0.5 per cent today to 3.5 per cent by 2020, starting with a rate hike in the fourth quarter of this year. (The PBO does not speculate on whether the central bank will cut rates before then, as some analysts are expecting it will do on Wednesday.
That will gradually push up the average mortgage rate to 5.3 per cent by 2020 from 3.2 per cent as of last year, while rates on non-mortgage loans should jump to 8.1 per cent from 5.3 per cent.
Interest payments alone will grow to make up 9.6 per cent of after-tax income by the end of 2020, up from 6.3 per cent at the end of last year, although still lower than the historic peak of 11.2 per cent, last hit in 1990.
Despite the rise, mortgage rates are expected to remain 65 basis points below their long-term average of 5.9 per cent, the PBO said, while non-mortgage debts will rise close to long-term levels of 8.2 per cent. (There are 100 basis points in a percentage point.)
Still, rising rates will mean a hit to household budget, the PBO predicts. It expects the debt-service ratio to hit 15.9 per cent in 2020, well above its long-run average and one percentage point above its 25-year peak, last hit in 2007. If interest rates were to rise to long-term levels by the end of 2020, the debt service would be even higher, hitting 16.2 per cent, meaning that Canadians would be spending $16.20 out of every $100 of after-tax income on debt payments.
"Based on PBO's projection, the financial vulnerability of the average household would rise to levels beyond historical experience," the PBO wrote.