Statistics Canada regularly publishes the ratio of total household debt to disposable income. Since this ratio has been steadily rising, its publication alarms and reminds Canadians the extent to which they are in debt relative to their incomes available for spending and saving. More debt means committing more income to pay-off debt, reducing the potential to save for any contingency including saving for children’s higher education, and eventually, retirement. Not only that, highly indebted Canadians would have limited money left over for paying monthly bills, and other committed expenses, and for day-to-day spending on essentials. This personal spending is one of the key ingredients of economic growth. The bottom line here is that if indebtedness of Canadians continues to grow and they have less and less money left to spend and/or save, it’s eventually going to affect the health of the economy. We may witness a home-grown economic recession resulting in from this steadily growing household debt.
In this note, I comment on the rising indebtedness of Canadians over the last three decades: 1984-94, 1994-2004, and 2004-2014. Besides talking about the two main components of household debt, i.e., mortgage and consumer debt, I show in the accompanying charts the increasing role of consumer debt in household consumption expenditure or spending, which in turn, plays a role in boosting the economy’s health. In other words, consumer debt is not only becoming more and more instrumental in maintaining household spending but also increasing its proportion of nation’s gross domestic product (GDP). This debt induced growth can’t last for ever. Eventually, Canadians are going to be squeezed in their own financial web.
Debt-to-income ratio has been rising
The ratio of total debt outstanding to household disposable income has risen from 57.4% in 1984, to 92.8% in 1994, 115.5% in 2004, and 158.2% in 2014 (Chart 1). This shows that in 1984, we Canadians owed 57 cents of each dollar of disposable income; thirty years later, we are owing one dollar and fifty eight cents – meaning we owe more than our disposable income (since we are using macro data, we are referring to a national picture rather than of specific groups of households owing debt or no debt). Nationally, we have substantially increased our debt liability. Since both the size of the economy and population have increased over time, we measure changes on a per capita or per person basis. For instance, our total debt per person has risen from $6,370 in 1984 to $49,740 by 2014 – an increase of 7.8 times, compared to the 3.1 times increase in our per capita income – from $17,900 to $55,560. This shows that we have been raising our indebtedness at a rate faster than the growth of our national economy (Chart 2).
Mortgage debt is the bigger component of total debt outstanding
Mortgage debt is the bigger component, constituting 68.4% of the total debt in 1984, rising to its maximum share of 74.6% in 1993, then dropping to 68.3% by 2004, and then climbing again since 2010 to 70.5% by 2014 (Chart 3). The highest mortgage share during the early nineties can be attributed to the hectic pace of purchasing and upgrading of houses by the so called ‘baby-boomers born between 1946 and 1965’ who were then aged between the late twenties (likely buying their first homes) and mid forties (likely purchasing up-graded homes). On the other hand, their corresponding cohorts, born between 1965 and 1984, were purchasing homes in 2010 and after with relatively higher mortgages – including the short period when buyers could purchase a house with no down payment at all, or move into a fully mortgaged house. Again, during the early 2000’s, the federal government of the day tinkered with the amortization period, relaxing to 40 years from the conventional 25-year term, which in turn, may have encouraged potential buyers to take higher mortgages. Right now, we are back to the conventional 25-year term.
Also keep in mind the way the concept of mortgage debt is defined here. This includes not only the amounts taken to buy the first house, but also any subsequent upgraded house(s), house purchased for investment purpose to generate rental income, loans taken as reverse mortgages to pay off consolidated debts, or to finance children’s higher education, or have funds for a new or on-going business. Here, the home equity (i.e., the market value of home less its mortgage debt outstanding) plays a crucial role of a secured collateral that can be used to borrow funds to meet any contingency.
Use of consumer debt is growing
Consumer debt, on the other hand, represents all debt outstanding on different credit cards issued by banks, department stores, other retailers and institutions, student loans, car loans, secured and unsecured lines of credit, and all other outstanding loans and unpaid bills. This debt is open to use to purchase all kinds of goods and services ranging from travel, entertainment, household goods and appliances, to paying bills, and for some really financially straitened, for putting food on the table. Its share of total debt had remained around 30% with the exception of 1993 when its share dropped to its lowest at 25.4%. However, looking at this debt outside its share of total debt, it is worth noting that consumer debt per person has risen from $2,012 in 1984 to 14,662 by 2014 – an increase of 7.3 times compared to the eight-fold increase in the mortgage debt (Chart 4). This increase in consumer debt between 1984 and 2014 can be attributed two factors: first, the growth (3.2 fold) in households’ consumption expenditure exceeding the growth (2.8 times) in its disposable income, and second, the heavier overall indebtedness pushed by factors like different incentives offered by credit cards, pitches of car loans with no down payment, and accessibility of lines of credit at low interest rates. For a household with expenditure exceeding income, and no liquid saving available, there is hardly a choice other than to use credit to purchase the desired goods and services.
Consumer debt represented 21.4% of total household consumption expenditure in 1984, rising to 26.1% by 1994, 37.4% by 2004, and 48.6% by 2014 (Chart 5). Put another way, consumer debt was one-fifth of total consumption expenditure of households in 1984; thirty years later, it’s nearly one-half. If this debt is cushioning up household spending, and this spending being a key component of our national economy, then evidently this debt is equally helping the economy float and grow. Consumer debt, which represented 11.2% of our nation’s gross domestic product (GDP) in 1984 jumped to 26.4% by 2014 (Chart 6). Even though the household spending as a proportion of GDP hasn’t changed much over the last thirty years (just hovered between 53% and 56%), the importance of consumer debt to the growth of the economy has been growing.
Most of the changes occurred between 2004 and 2014
Most of the changes in the key financial components of households occurred over the 2004-2014 decade.For example, of the total increase of $1.5 trillion in GDP (in current market prices) between 1984 and 2014, 21.6% was over the 1984-94 decade, 35.5% over 1994-2004, and 42.9% between 2004 and 2014 (Chart 7). On the other hand, of the total increase of $1.6 trillion in total debt, 58.2% alone occurred over the 2004-2014 period. This is the period when the real estate market went through dramatic changes including a sudden surge in prices of homes across the land, pushing demand for larger sums of mortgages, tinkering with rules on down payment, mortgage amortization term, uncertain economy, low interest rates, role of foreign buyers and speculators, and stagnant incomes. As a result, the likelihood of owning a home, a cherished dream of each and every Canadian family, seems to be slipping away for certain demographic groups.
The growth in debt isn’t going to stop. Keep in mind that not all debt is bad. Any debt taken to improve income potential or to acquire an asset is considered as a good debt. Canadians, including potential immigrants, aspiring to own a home, are going to take hefty mortgages to purchase a home. Similarly with tuition and other costs of obtaining higher education rising, persons aspiring to acquire higher education or upgrade skills are going to take more student loans. With incomes stagnant, rising expenditures are equally going to make households borrow more to finance their needs. Middle income families are no longer the exclusive users of consumer credit. Affluent families use it too for convenience, or to reap benefits and rewards (like air travel including insurance) offered by credit cards. Canadians have to use some degree of self-discipline to use credit wisely and within their financially comfortable boundaries. That’s one way to slow down the growth of household debt.
(See my next blog on the concept of minimum payment and the small-print statement, though legally required, on the number of years it will take to pay off the balance – something we see in our monthly credit card statement).