Household finances

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An unspoken part of the concept of ‘Affordability of Home’

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Lately, we have been reading a lot about the grave crises of owning a home for Canadians between the ages of 25 and 45. Since prices of houses are skyrocketing relative to the sluggish growth of their incomes, owning a home for these people is becoming beyond their reach.

To help these Canadians own a home, the federal and provincial governments have been hard at work developing measures to facilitate homeownership – varying from a single detached to a garden home to a condominium in a high-rise building. A potential buyer’s choice of the type of house purchased depends, besides other personal considerations, on how much money that buyer can pay as a down payment and how much of the mortgage he/she is qualified to have.

Current affordability test

In Canada, a potential home buyer must qualify the initial two-layered test of affordability of a home: first, a buyer spends no more than 30 – 32 percent of the household’s gross income on the mortgage payment, property tax, and utilities, including heat, hydro, and water; and second, a buyer can maintain spending the same percentage of gross income if the interest rate on the mortgage were to increase by another two percentage points.

Government incentives to potential buyers and developers

To further help potential buyers in Canada, the federal government, in its latest annual budget/economic statement, announced a few new measures: first, a mortgagee can pay off the mortgage over a span of 30 years instead of the standard 25 years – in other words, increased the so-called amortization period; and second, a buyer can have mortgage insurance (to protect the lender’s money) on a home worth up to $1.5 million – raising it from the previous limit of one million dollars. To cap it all up to facilitate home ownership, the government has further removed its share of Goods and Services Tax (GST) on the purchase price of a home bought by first-time buyers. These measures were in addition to the incentives already in place that allowed a potential buyer to use funds from his/her Home Ownership Savings Plan and/or a Registered Retirement Savings Plan (RRSP). Any funds a buyer withdraws from RRSP are to be put back in the plan within ten years after buying a home.

To help developers, on the other hand, federal, provincial, and municipal governments are providing land, financial help in land development, construction costs, and rapid license approvals, besides other requirements to expedite the construction or supply of new housing units. The emphasis is on constructing multi-unit high-rise buildings or stacked dwellings (considering the scarcity of habitable land).

All such incentives for potential buyers and builders are meant to provide expeditiously a roof over the head for the younger households or those newly arrived in Canada. A household has a perfect choice to own or rent a unit. To own a unit, a household can either pay the unit’s full price or take a fixed or variable-term mortgage at a given interest rate, amortized over a conventional 25 – 30 years. And, if a household opts to rent, it signs a lease stating monthly rent and other terms and conditions of living in that unit.

Owning a home requires a significant investment and long-term legal and financial commitment. For most Canadian households, their home is their primary asset – an asset that requires a large sum of money to acquire and a good amount of income flow and savings to maintain it, i.e., paying not only for utilities and property tax but also its furnishings and equipment, insurances, repair, renovation, in/outside care, installation of security – to name a few relevant maintenance expenses that some homeowning families are not that comfortable to handle. These families may have passed the core affordability test, on or near the borderline of buying a house. However, after its possession, they will have a problem maintaining it. Such families are also termed as ‘asset rich but cash poor.’  

The unspoken part of the affordability concept

The current concept of affordability is misleading as it lacks vital components, such as a potential buyer’s net income flow, expenditure pattern, and savings to lean on or meet unexpected expenses. The current concept uses the buyer’s household gross income before income tax and other deductions and guesstimates of utilities. Since the mortgage and all other regular and unexpected expenses are paid out of the net income and savings, a potential buyer fails to see the exhaustive nature of expenses he/she would incur on the home from the household’s current financial capability. A borderline buyer is too enthused to consider the future potential expenses and sign the purchase agreement.

The outcome of this financial miscalculation

The outcome of this miscalculation is calamitous. The shortage of cash and likely no personal savings compel a household to rely more on debt, including excessive use of credit cards, line(s) of credit, if available, and other borrowings from banks and other institutions, relatives, and friends. Since this debt is in addition to the mortgage debt, a household is now heavily indebted and is obligated to make additional debt payments from its net income, leaving less to pay the regular bills and other unexpected or unplanned obligations. Over time, this home-owning household is overburdened with colossal debt and must put the house on sale or receivership.

An inability to pay this excessive debt load may cause several health issues for the borrower (s), including physical and mental stress, insomnia, and heart disease. On the personal side, it may cause disharmony in a household with a couple arguing and blaming each other for the financial mess they find themselves in. So much so, that they may eventually decide to part ways and dissolve their household unit.

The house a couple in love entered with all the pride and happiness one day now exits the house on separate ways with anger, frustration, remorse, and blaming each other – all because of their financial inability to afford a home. A couple could have avoided all such misfortune if they had taken a realistic view of the expenses involved in owning and maintaining a home, even if they had qualified for the current two-layered test of affordability.

Current affordability test

In Canada, a potential home buyer must qualify the initial two-layered test of affordability of a home: first, a buyer spends no more than 30 – 32 percent of the household’s gross income on the mortgage payment, property tax, and utilities, including heat, hydro, and water; and second, a buyer can maintain spending the same percentage of gross income if the interest rate on the mortgage were to increase by another two percentage points.

Government incentives to potential buyers and developers

To further help potential buyers in Canada, the federal government, in its latest annual budget/economic statement, announced a few new measures: first, a mortgagee can pay off the mortgage over a span of 30 years instead of the standard 25 years – in other words, increased the so-called amortization period; and second, a buyer can have mortgage insurance (to protect the lender’s money) on a home worth up to $1.5 million – raising it from the previous limit of one million dollars. To cap it all up to facilitate home ownership, the government has further removed its share of Goods and Services Tax (GST) on the purchase price of a home bought by first-time buyers. These measures were in addition to the incentives already in place that allowed a potential buyer to use funds from his/her Home Ownership Savings Plan and/or a Registered Retirement Savings Plan (RRSP). Any funds a buyer withdraws from RRSP are to be put back in the plan within ten years after buying a home.

To help developers, on the other hand, federal, provincial, and municipal governments are providing land, financial help in land development, construction costs, and rapid license approvals, besides other requirements to expedite the construction or supply of new housing units. The emphasis is on constructing multi-unit high-rise buildings or stacked dwellings (considering the scarcity of habitable land).

All such incentives for potential buyers and builders are meant to provide expeditiously a roof over the head for the younger households or those newly arrived in Canada. A household has a perfect choice to own or rent a unit. To own a unit, a household can either pay the unit’s full price or take a fixed or variable-term mortgage at a given interest rate, amortized over a conventional 25-30 years. And, if a household opts to rent, it signs a lease stating monthly rent and other terms and conditions of living in that unit.

Owning a home requires a significant investment and long-term legal and financial commitment. For most Canadian households, their home is their primary asset – an asset that requires a large sum of money to acquire and a good amount of income flow and savings to maintain it, i.e., paying not only for utilities and property tax but also its furnishings and equipment, insurances, repair, renovation, in/outside care, installation of security – to name a few relevant maintenance expenses that some homeowning families are not that comfortable to handle. These families may have passed the core affordability test, on or near the borderline of buying a house. However, after its possession, they will have a problem maintaining it. Such families are also termed as ‘asset rich but cash poor.’  

The unspoken part of the affordability concept

The current concept of affordability is misleading as it lacks vital components, such as a potential buyer’s net income flow, expenditure pattern, and savings to lean on or meet unexpected expenses. The current concept uses the buyer’s household gross income before income tax and other deductions and guesstimates of utilities. Since the mortgage and all other regular and unexpected expenses are paid out of the net income and savings, a potential buyer fails to see the exhaustive nature of expenses he/she would incur on the home from the household’s current financial capability. A borderline buyer is too enthused to consider the future potential expenses and sign the purchase agreement.

The outcome of this financial miscalculation

The outcome of this miscalculation is calamitous. The shortage of cash and likely no personal savings compel a household to rely more on debt, including excessive use of credit cards, line(s) of credit, if available, and other borrowings from banks and other institutions, relatives, and friends. Since this debt is in addition to the mortgage debt, a household is now heavily indebted and is obligated to make additional debt payments from its net income, leaving less to pay the regular bills and other unexpected or unplanned obligations. Over time, this home-owning household is overburdened with colossal debt and must put the house on sale or receivership.

An inability to pay this excessive debt load may cause several health issues for the borrower (s), including physical and mental stress, insomnia, and heart disease. On the personal side, it may cause disharmony in a household with a couple arguing and blaming each other for the financial mess they find themselves in. So much so, that they may eventually decide to part ways and dissolve their household unit.

The house a couple in love entered with all the pride and happiness one day now exits the house on separate ways with anger, frustration, remorse, and blaming each other – all because of their financial inability to afford a home. A couple could have avoided all such misfortune if they had taken a realistic view of the expenses involved in owning and maintaining a home, even if they had qualified for the current two-layered test of affordability.

Keywords: Homeownership, First-time home buyer, Affordability, Two-layered affordability test, Household gross income, Household net income, Mortgage debt, Household total debt, Household expenditure, Savings, Home maintenance expenditure, Bankruptcy, Receivership, Household disharmony.

Are All Goodies Being Offered by Parties Vying for Power in 2019 Election Make Sense?

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Introduction
It’s election time in Canada. Canadians go to the polls on October 21, 2019. All political parties and their leaders vying for power are offering their election manifestos, that is the menu of goodies along with their projected costs to be offered to families, things and tasks that they will do and/or accomplish, if elected to govern. Nothing unusual. Parties and leaders in all democratic countries, developed and undeveloped, follow the same procedure. Canada is no exception. For politicians, the election time is the time to show who can offer voters the best of goods and services with voters’ own money. That’s also considered bribing voters with their own money. 

And what’s the politicians’ source of providing financial help to voters? Money collected by government as direct income and sales taxes from taxpayers, their mandatory and voluntary contributions and deductions on several federal and provincial plans, excise, corporate taxes, and all other indirect taxes – the key sources of government revenue, besides borrowings.

In the upcoming October election, there are six parties vying to form a government: the incumbent Liberals, Conservatives, New Democrats, Green, Bloc Quebecois, and People’s. This blog is not intended to synthesize the manifesto of each of these parties. It’s simply focused on the two specific goodies being offered by the two main contenders, the Liberals and Conservatives: first, offering more income to low and middle income class voters by tweaking the rate of first income tax bracket, giving additional tax credits, or by raising limit of basic income exempted from tax as well as by raising benefits currently provided under Canada Child Benefit  program; and second, offering help to first time home buyers.

Do the stated ways and means of providing help to families in respect to these two commitments make sense and really help voters or are just  gimmicks to get votes? 

Let’s look closely at each. 

Raising incomes of low/middle income voters and their families

The conservatives’ slogan is to put more money in the pockets of low and middle class families and help them move forward. To do it, the Party is proposing to reduce the first income tax bracket from the current 15% (brought down from 17% by the Liberals after the 2015 election) to 13.5% along with tax credit of $1,000 annually for each child for fitness and sports-related activities, $500 for children’s arts and educational activities, another $500 for parents with children with disabilities. Besides these, the Party is offering a transit credit worth 15% that tax filers spend on buying monthly passes for using public transport including buses, streetcars, subways, or local ferries, designed to cut emissions causing air pollution. Most of these credits are being re-introduced from Mr. Stephen Harper’s era , as these were terminated by the incoming Liberals in 2015.

The Liberals, on the other hand, are proposing to increase the amount of basic income exempted from tax from $12,000 to $15,000 for all tax filers. In addition, the Party is proposing to increase Canada Child Benefits by another 15% for children under one year of age as well as benefits under Old Age Security (OAS) program by 10% for persons aged 75 and over.  The Party recognizes that families need more money at these stages of their life cycles.

Both parties seem to agree to help parents of the newborns while they are receiving Employment Insurance. The Liberals want to make such benefits tax free at the source whereas the Conservatives are offering 15% tax credit at the time of filing tax return.

With all these proposed changes in the first income tax bracket and different tax credits against the changed threshold of basic income exempted from tax, one may ask how much it’s going to cost the government, and how much additional income a low/mid income family is going to get at the end of a year? The best educational guess is that it’s going to cost around $7 billion and taxpayers and their families will gain anywhere between $500 to $1,000 (Mr. Scheer, the Conservatives leader, in a recent English language debate said that a couple would gain $750). Assuming that each eligible family will gain a net income of $1,000 at the year end, which in turn, can be translated to around $3 a day – not enough to buy even an average size bottle of cooking oil. How far families will get ahead with this petty amount? Politicians really need to think before making any meaningful offer to attract low/mid income voters’ favour.

Again, in respect to offering different tax credits to children and transit credit to those using pubic transport, this concept is really not that equitable. What about offering tax credits to single-person families, or those with two or more members without children. Even all those with children and eligible to get credits wouldn’t be tempted to send their kids to such activities simply because petty credits are available. Because it takes more than that for parents to decide whether to send their children to such activities as parents have to take into into account several other factors including costs of accessories, equipment and facilities associate to such activities , besides their own time and resource commitments. The reality is that that only those in the upper and higher income brackets, who could afford to send their kids to such activities, will benefit from these son called “Boutique” credits.

In the same manner, offering transit credit to users of public transport is inequitable too. What’s wrong with those who drive to work, or share carpools, etc.? These people also incur transportation costs and some may even need assistance.

Since a good majority of families are carrying a load of consumer and/or mortgage debt, and living in financially straitened circumstances, receiving, say $1,000 at the end of the year may make them momentarily happy. Nothing else is going to change. Leaders of both Parties maybe happy to keep their words too – “putting more money in the pocket of a low/mid income family” – costing billions of dollars a year to the federal treasury. But for an individual recipient, this negligible financial help is not going to make any dent in his/her pocket.  

So as I see it, it’s just a politicians’ token gesture to win votes.

However, if one looks from a politician’s perspective, his/her objective is to look good in the eyes of the electorate. He/she is doing something not only to re-distribute incomes, but also helping the economy grow by making families spend more. He/she knows that all of this additional money given to low/mid income families will be spent right away, boosting the nation’s economy. Keep in mind that consumer expenditure accounts for close to 60% of our gross domestic product (GDP) – an economic measure of the size of the economy that values all goods and services produced by the nation.

Help to first time home buyers

Again, let’s start with the Conservatives. The Party has proposed two key measures: first, to extend the mortgage amortization period from the current 25 years to 30 years; and second, to drop the current eligibility criteria that a potential first time buyer would be able to retain property if the current mortgage rate increased by another 2% (currently known as 2% test). The former is aimed to facilitate the issue of affordability. 

The Liberals, on the other hand, are going to increase the thresholds of both the family income (to $150,000) and purchase price of home (to $800,000); the latter indeed varies not only by province , but also within urban and rural cores of cities of each province. This increase in the  thresholds is in addition to the already available 10% of home equity to the first time home buyers to give them a head start. This equity is held by the crown corporation Central Mortgage & Housing Corporation (CMHC). Put another way, CMHC will contribute 10% of the purchase price to start with (besides the down payment made by the potential owner). Keep in mind that this chipping in of 10% of loan by CMHC has to be paid back over the years by the owner, or at the time the house is sold. The Liberals are not talking about either the the current 2% test, or the change in amortization period, or the issue of affordability of home. This changing of the threshold of purchase price may result in an increase in the price of home, forcing a buyer to take more mortgage debt. 

Now let’s look at the implication of the Conservatives’ proposal to increase the mortgage amortization period from 25 to 30 years. No doubt any increase in amortization period will bring down the monthly mortgage payment, and that means more cash available for other needs for a financially hard pressed new home owner. The Party thinks it is helping the first time buyer when in fact, it’s making the owner to keep paying debt for another five years, dishing out more interest payments. Any extension of amortization period will indeed financially benefit the lender at the borrower’s expense. That’s not helping the buyer, but putting him/her in a longer financial distress. 

To illustrate this point, let’s consider a buyer with a mortgage of $400,000 at 4% interest. The monthly payment is $2,104 with 25 year amortization and $1,902 with 30 year – a difference of $202 a month. The home owner is happy that he/she has additional $202 in cash available for other needs. Assuming all else constant, and interest rate remains unchanged, that owner would pay (according to the Bank of Nova Scotia’s Mortgage Calculator available on Google) total interest amounting to $284,748.48 over 30 years on $400,000 mortgage loan compared with $231,224.30 over 25 years. In other words, an increase in amortization period from 25 to 30 years will cost the owner $53,524.18 extra in interest alone. Indeed he/she would be able to have extra cash $72,720 (= $202 x 12 x 30) for other needs, but with extra interest of $53,524. That means, for each dollar of extra cash, he/she paid 74 cents in interest. Is that a good deal to offer? Not at all. In my professional opinion, any lengthening of amortization period is the worst disservice one can offer to the first time home buyers.

It’s rather unfortunate that the Conservatives have failed to recall that when their peers were in power with Mr. Stephen Harper at the helm with Mr. Jim Flaherty as Finance Minister, they tried to introduce measures like no down payment and 40 year amortization in order to boost the housing industry and in turn, the economy. There was a huge public outcry that we were putting home owners in a rather miserable situation. Not only that, the longer amortization period would deny them the opportunity to save for their children’s higher education, retirement, etc. as they would be spending their work life paying off the mortgage. Mr. Flaherty listened and he brought back the provisions including 5% down payment with 30 year amortization, and with continuing public dissatisfaction, brought back amortization period to conventional 25 years. 

I don’t know why the current Conservative leader has not paid attention to what happened in his backyard years ago. Extending amortization period is not a good proposal by any sense.

The Conservatives’ second proposal about getting rid of 2% test makes sense as the measure is meaningless to begin with. Since a family income can change due to several factors including the loss of job of the primary or secondary earner in a volatile labour market and shifting economy, their sickness or disability, or family’s dissolution over time, what good is the criteria that qualifies a family on the day it is assessed, but what happens to it or its ability to afford a home after that day is anybody’s guess. Moreover, this test is based on a specific criteria: monthly payment of mortgage plus property taxes plus utilities as a proportion family’s monthly income should be under one-third of income (at current interest rate and at +2% rate). A family may qualify this criteria, but in reality it can be in a real financial hardship as there are umpteen other expenses associated with maintenance and furnishings of a new home, besides other expenses on food, clothing, persona care, and children’s education – to name a few.

In my professional opinion, this criteria of qualifying a family that it can afford a home is totally meaningless. It may cause more pain and financial stress to a potential home owner than helping it to own it.

The Conservatives are rightly proposing to get rid of this 2% test used as a qualifier to own a home.

Conclusion

I would say that the proposed plan as put forth by the leading two contenders about putting more income in pockets of  low/middle class families is just an election plank and would hardly make a dent to their overall well-being. And, the proposal to increase amortization period from 25 to 30 years is a big disservice to the first time home buyers.

Key words: Family income, Middle class, Income tax, Tax rate, Tax credit, Child benefit, Home ownership, Mortgage debt, Amortization, Interest payment.  

 

Are Canadians aspiring to own a home looking for ‘goodies’ in the federal budget on March 19, 2019?

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Introduction
March 19th is the day the federal government presents its last budget of its current mandate. Since this budget is leading up to October election and will be a core of Liberal’s platform, it has to have some goodies or incentives for voters to re-elect Liberals. Even last night a CBC journalist was speculating that the budget will be taking into account access to high-speed internet in both rural and urban areas (offsetting the current divide), financial help to Canadians to improve and upgrade skills to stay competitive in the job market, and also help millennials and other middle-income families to purchase a home in today’s highly volatile, competitive, and almost inaccessible housing market.

The question is what sort of incentives or help our Finance Minister, Mr. Bill Morneau, can provide? This note looks at this issue.

Possible Venues
Essentially, the following are some key tools he can tinker with:
1. Reduce minimum down payment;
2. Increase amortization period to pay off mortgage;
3. Adjust the eligibility criteria;
4. Increase amount that an owner can borrow from his/her RRSPs and pay back over a period longer than the current ten years after owning a home;
5. Financial subsidy or incentive (I don’t think he can place any threshold on interest rates charged on mortgages as that would be considered as intervening in capital markets; he may, however, drop the current so-called “financial stress test” that looks at owner’s ability to pay off mortgage if it went up by 2% from the current rate).

Some of these tools have been used in the past and the result or public reaction has not been that positive.

For those who still remember the times when conservatives led by Mr. Harper with his ever pleasant Finance Minister, Mr. Jim Flaherty, tried to boost the housing market in a sagging economy. At one point, Mr. Flaherty allowed potential home buyers to buy a home with no down payment. And many hungry buyers rushed to own a home, but unfortunately, had no or little means to maintain it or keep it for too long. There was a public outcry that the government was pushing people to more financial hardship by allowing them to move into a home with no down payment – home they can’t afford to maintain. The Finance Minister listened and back-tracked to 5% minimum down-payment.

Then he tinkered with amortization period, increasing it from the conventional twenty-five to forty years. Again there was an outcry that with amortization that long, people would not only be paying a lot of interest to banks and other financial institutions issuing mortgages, but also have no time to save any anything over their work life for say children’s higher education, or personal retirement – assuming forty years is a standard work-span (or, from 25 to 65). So there was another re-tracking; we moved back, first to 35 years, then 30 years, and finally to 25 years – the conventional amortization period.

Since Mr. Morneau is likely aware of these tinkerings that one of his former counterparts tried to help potential home buyers, and in turn, boost the economy, I don’t think he is going to change the minimum down payment; he may change the amortization period to thirty years as people are now living and working longer, even past their seventies.

As far as adjusting the eligibility criteria – mortgage debt plus property tax plus heating cost shouldn’t exceed 30% of buyer’s net household income – set by our Crown agency, the Canadian Mortgage and Housing Corporation (CMHC) may be changed as mortgage amounts have been sky rocketing relative to incomes of households. It can be raised to 35 – 40%. During the seventies and early eighties, a typical homeowner’s mortgage amount taken was around three times its household income compared to eight to ten times today (as the rising home prices have pushed up the demand for mortgage amounts. No wonder, home ownership is slipping away from the reaches of many young and middle-income households. And those who are living and maintaining high mortgage homes are likely financing their day-to-day needs by using consumer credit including credit cards and secured and unsecured lines of credit. It’s a double debt whammy – young and mid-income home owners are overloaded with debt. Under these conditions, many may not pay back the money they borrowed from their own RRSPs over ten years. Here again, Mr. Morneau can help these families by extending the pay-back period.

One possible Band-aid
There is one way the federal Finance Minister can help mid-income home owners or those aspiring to buy a home. Make annual interest paid on mortgage on primary residence as non-refundable tax credit – like we do on many other annual expenditures including student loans used to upgrade skills, or use of public transport to reduce pollution and protect environment, and on and on. What’s wrong with the cost of owning a home – it’s not only the key asset of Canadians, but also its acquisition helps the domestic economy. On such annual expenses, tax payers get 15% credit at federal level and some portion at provincial level (for instance, it’s 5.5% for those living in the province of Ontario). Considering that nearly two-thirds of all households live in an owned home, and roughly six out of ten such households own a mortgage, I can understand the high cost to taxpayers over the years. To that effect, we can make this credit either ‘income dependent’ (like CMHC doesn’t provide mortgage insurance on a home worth one million dollars or more) or set some maximum limit on mortgage interest paid – either way, we are financially helping those who need help, and that’s what our tax system is all about – not only to reduce the income inequality, but also to help those who need help. Look at GST tax credits, children’s benefits, and other social assistance programs – all designed to help the needy.

Let me illustrate by an example. Say, a home owner in Ontario has a mortgage debt of $400,000; considering he/she has a closed 5-year mortgage at 5% interest (to be amortized over 25 years), he pays $21,326.85 as interest in first year, $20,896.52 in second year, and so on. Using 15% of tax credit at federal level and 5.5% at provincial, he/she will be entitled to credits of $3,199.03 and $1,172.98 respectively in the first year, $3,134.48 and $1,149.31 in the second year, and so on (showing that as interest slides down over the years, so would credits). So a homeowner gets financial help worth $4,372.01 in first year, $ 4,283.79 in second year, and so on. These are small amounts and are affordable at both levels of governments; on the other hand, these amounts can help a cash-hungry homeowner.

In my opinion, allowing annual mortgage interest paid on principle residence as a tax credit is a win-win situation for homeowners and federal and provincial governments. Some may argue that it’s not fair for those owners with no mortgage or for those not owning a home. Indeed they have a point about fairness. But the kind of tax system we currently have, there is hardly any tax credit that’s universally applicable to all taxpayers.

I rest my case.

Tags Mortgage debt, consumer debt, household finance, home-ownership, home as asset, federal/provincial government, housing, tax credit, tax system

Using debt wisely: a skill or a behavioral issue?

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Introduction
To help Canadians manage their money better, the federal government established a Task Force in June 2009, and mandated it to make recommendations to the Minister of Finance on a national strategy to improve financial literacy of Canadians. This task force released its report in December 2010 with thirty recommendations, including one to conduct periodically a national Survey of Financial Capability of Canadians. The first such survey was conducted by Statistics Canada between February and March 2009, and a short report containing these data was released in December 2010.

The Task Force’s report entitled Canadians and their money: building a brighter financial future is available at http://www.edugains.ca/resourcesFL/Background/CanadiansAndTheirMoney-2011.pdf.

Is financial literacy program of any help?
To promote financial literacy is a topical concern – especially in the current environment when most Canadians are steadily increasing their indebtedness due to stagnant incomes, changing labour market providing more precarious than well-paying jobs, creating a gulf between the earnings of those with and without the marketable skills. Then, on the demographic side, we are witnessing more family dis-solutions resulting in more women-headed single parent families, most with jobs with low-to-medium hourly wage rates in the services sector, likely vulnerable to rely on consumer credit. Yet another demographic group likely to use credit constitutes the rising number of the elderly living on fixed incomes including work-related and/or private pensions, and benefits from Canada Pension Plan, Old Age Security, and Guaranteed Income Supplement.

Besides these labour market and demographic forces pushing individuals and families to use consumer credit, low interest rates and sky-rocketing prices of homes, making buyers to take mortgages beyond their financial means, are also likely pushing current and new or potential homeowners to rely more and more on consumer credit, including charge cards, unsecured lines of credit, and other secured and unsecured loans for their day-to-day spending needs. Unfortunately, as the rising prices of homes are making home ownership beyond the reach of many, it’s creating, on the other hand, a bonanza for all those renting properties. These landlords are free to raise rents year after year, making tenants to spend more and more on rent, and use charge cards and other loans to meet their day-to-day living expenses.

Then there are individuals, mostly with low education, unskilled, and holding short-term or temporary jobs, who in turn, can’t secure credit cards and/or loans issued by banks and/or other financial institutions. They have either been denied access to credit cards because of their low incomes, or have exhausted their permissible spending limits on their existing cards. A good number of these individuals turn to private lenders like Payday Loans, Money Marts, or Cash-on-the spot, and become their prey for life. Such lenders or money sharks thrive on such poorly educated needy low earners who are prepared to meet their daily needs with funds borrowed at exorbitant rates. My heart goes to such people. For them, paying one loan with another becomes a part of their life.

Even though the Canadian federal government in cooperation with several provincial governments have been introducing some measures to protect such borrowers paying sky-rocketing interest rates, the measures in place are largely focused on controlling interest rates, but not the borrowers’ behaviour, or options to use funds from other sources. Since Canada respects an individual’s freedom, values, and right to choose his/her lifestyle, an individual is free to borrow money from any source he/she so chooses.

Individuals and families living with no or little cash flow are presumably living in financially straitened circumstances. Granted, some may have voluntarily abused credit by spending frivolously on acquiring luxury goods, misused student loans, taking expensive holidays, maintaining a lifestyle they could hardly afford, stretched themselves beyond their means, but the majority use credit to meet their current essential and nonessential expenses. The question I ask here is if any financial literacy program can help such users of credit, instruct them to manage their money better, save more for the rainy day, or for children’s post-secondary education, and above all, save for personal retirement.

In my view, no financial literacy program is going to help such individuals if their day-to-day living is at stake and they simply need immediate access to cash – even if it means going deeper into indebtedness. For such individuals, the survival is at issue. For them, offering them any course guiding them to handle money properly is like a drop of water on an oily surface. The mere lecture about managing money is not going to help meet their financial needs, or their day-to-day challenges of survival.

On the other hand, the well-educated, holding skilled jobs with good wages and salaries wouldn’t really require such literacy program – partly because most of these have likely picked up some financial knowledge while pursuing higher education. They may not all be professional wizards, financial or money smarts, but such people can at least consider the pros and cons about choosing a lender, or comprehend the kind of loan agreement they are signing. According to the 2009 Survey of Financial Capability of Canadians, highly educated, high income, and financially knowledgeable individuals had much higher rate and amount of indebtedness than their low educated, low income, and not so financially literate, counterparts.

These better educated individuals, using credit wisely or unwisely, get credit at prevailing market interest rate, with scheduled payment plan from regular sources like banks, or other financial institutions. Their less educated, low income counterparts, on the other hand, would be more prone to turning to private lenders like Payday Loans, and Money Marts. The latter are likely to have either no clue about the aftermath of what they are doing by borrowing money from such lenders, or their need is so strong that they give a damn to what happens to them the next day, next week, next month. What they want is immediate access to cash money even if it leads them to a deep and suffocating hole.

Theoretically speaking, the financial literacy program should be good for low-to-mid income people who can’t handle or manage their money better. This program will indeed teach them a variety of skills to manage their money. However, what they really need first is a stable and a right frame of mind to concentrate on the learning process. And this they would have it only when they have good enough access to cash to meet their needs.

Once they have enough money, then only they can be taught some budgeting techniques, ways to save, ways to control spending, ways to use debt wisely, etc. In addition to helping Canadians to improve their financial capability, both the federal and provincial governments should introduce measures aimed at moderating the demand for credit – like moderating the rising prices of homes, volatility in both the real estate and financial markets, and consumers’ habits of spending borrowed money. For example, if we can bring down the purchase price of a home, we can also bring down the amount of mortgage debt required and its associated monthly payment – all resulting in a more cash, or lesser use of credit, for an owner. The sad part is that no government would like to introduce such measures controlling credit as all of these, in one form or another, essentially help the growth of the nation’s economy. And, who wants to stop that?

Empirical evidence that the financial literacy program is not working

Since 2009, the year the program was introduced by the federal government, Canadians overall owe more today than they did eight years ago. For instance, for each dollar of disposable income they made, they owed $1.67 in 2016 compared with $1.55 in 2009. Between these years, the overall household debt has risen from $1.4 trillion to $2.0 trillion – an increase of $600 billion. And, 80% of this increase is attributed to the increase in residential mortgages, and the other 20% to consumer debt. The rate of growth of total debt (42.8%) has outpaced the rate of growth in personal disposable income (32.3%). Put simply, Canadians are spending money they haven’t yet earned. It’s long-term effects are not good either for the economy, or for the future generation.

Using debt wisely – a skill or a behavioural issue?
Of the two debt components – residential mortgage and consumer debt – the indebtedness in respect to the former is by choice, and it’s considered as a good choice as long as it is made keeping viable affordability in mind, whereas that in respect to consumer debt is largely behavioural (with the exception of those with no savings or any cash flow, and who simply breathe on borrowed money).

Mortgage debt is considered as a good debt as it’s taken to purchase a home – one’s key asset over a lifetime – that also appreciates over time. As one pays off the mortgage debt over time, one builds equity in addition to the appreciation in the value of home due to the changes in the local and national real estate markets. This rising equity in home provides the owner some sense of future financial security. Any undertaking of mortgage debt requires some set of skills right from the choice of a lender to the negotiations about the amount sought, its amortization, interest rate, frequency of payments, lump sum payment without a penalty, etc. For example, an average person may opt for a monthly payment schedule whereas a more skilled may opt for a weekly payment, saving oneself thousands of dollars of interest by repaying borrowed money over a relatively shorter period.

Consumer debt, on the other hand, is largely considered as a bad debt as individuals use it for varying reasons – ranging from grocery shopping to taking holidays, paying off monthly bills, on-line shopping, taking cash advances – you name it. Since consumer credit is “cash available 24/7”, one uses it for day-to-day shopping of both essentials and non-essentials to satisfy one’s current needs or consumption, or maintain one’s lifestyle. The use of this credit also reflects one’s spending habits, or behaviour as a “sensible or conservative spender”, or a “compulsive or frivolous spender”.

Spending is a ‘behaviour’, and not a ‘skill’ to be learnt from any financial literacy program. For example, does one need any skill to order a product or book a vacation package on-line and pay by credit card? No. One wants something on the spot, orders it right away (impulsively or non-impulsively), and pays by readily available credit card, line of credit, or any other form of revolving credit. No second thought on the purchase, or any analytic aftermath.

The only way to control spending behaviour and its related borrowing is to learn to exercise some degree of self-control or budgetary restraints – which only a person him/herself can devise and implement. No classroom program is going to enforce it. How to exercise such restraints is a completely different topic, and beyond the scope of this short post.

Because of the prolific use of credit cards and easy access to lines of credit coupled with low interest rates, Canadians have increased their consumer debt load by 26% (or $118 billion) between 2009 and 2016. This translates to $46 million a day over seven years. That’s a hefty dose of daily consumer indebtedness that may even be hurting a particular segment of Canadians.

Tags:
Financial literacy, indebtedness, mortgage debt, amortization, equity in home, consumer debt, spending behaviour, conservative spender, frivolous spender, low-income, precarious job.

Indebtedness and depression

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Introduction
A couple of days ago when I released a post on a brief perspective on depression, I intentionally left out the details on a link between indebtedness and depression. I just wanted to highlight the possible sources of depression, its symptoms, and ways to overcome it. Considering the strong link between indebtedness and depression, this post is strictly focused on this topic. Do we have any evidence to support our exposition?

Currently available evidence
The evidence currently available is from studies conducted in the United States and Europe, including the United Kingdom, and Spain. The quantitative evidence is from the national or regional household surveys. For example, the survey of 8,500 people, conducted in the mid-nineties by the Institute for Research on Poverty and the Center for Financial Security at the University of Wisconsin-Madison, showed that people with credit card debt and overdue bills were much more likely to experience symptoms of depression than those without such debts. Again, those with student loans and mortgages didn’t experience bouts of depression that frequently compared to those who had too much credit card debt and outstanding unpaid bills. Keep in mind that the sort of depression experienced by these persons is different from the usual concept of ‘clinical depression’ or ‘chronic depression’.

Similar findings were found from data compiled from the three waves (2002-2005-2008) of the Spanish Survey of Household Finances, and presented in the IZA Discussion Paper # 8912, released in March 2015. Among other results based on multivariate models, it found that non-mortgage debt payments and debt arrears affected significantly people’s health. Mortgage debt didn’t affect health that badly as non-secured consumer debt (like amounts outstanding on credit cards, lines of credit, and other debt arrears) did.

Depression/health ailment varies by type of debt
How come mortgage debt and student loan cause lesser health problems or depression compared to other unsecured loans? It’s mostly the attitudinal and mental thinking about debt that makes the difference. For instance, people look at mortgage debt as a vehicle to acquire the biggest asset of their life – owning a home – and its repayment brings them more pride and security as they gradually increase equity in their home. The same with student loans. Persons take such loans to acquire higher education and skills to improve their employment prospects, job mobility, and eventually higher earnings. Its repayment equally doesn’t cause them any mental anguish as they realize that it was something required to improve themselves and their living standards. On the other hand, any debt used to satisfy current consumption, pleasure, travel, or as a bridge to get over spells of inadequate income during unemployment or emergencies could prove to be not only daunting but haunting as well. The payment of this accumulated non-mortgage debt including credit cards, car loans, lines of credit, etc. (excluding student loans) – depending on their respective rates of interest – could cause a serious anxiety and depression for debtors – especially when they have a poor cash flow or have scant or no personal savings. This anxiety and depression eventually affect debtor’s health.

What are some of the ramifications of indebtedness?
Statistics Canada continues to remind us that we carry more debt than we earn – the latest statistics show that we owe $1.68 for each dollar of disposable income (i.e., income after taxes and other deductions including premiums for Canada/Quebec Pension Plan, and Employment Insurance). This is a macro-picture at the national level, based on total household debt outstanding divided by total household disposable income. This ratio doesn’t imply that each and every household in Canada is in debt or owe some money – though a good majority does (according to TransUnion Canada, 26 million Canadians owed at least one type of debt) and most of the debt owed is mortgage debt taken by households to purchase their first home, or to refinance their home to raise funds for any personal reason (like pay-off consumer loans, investing in business, or financing a child’s higher education). With mortgage debt rising (partly as a result of steeply rising prices of homes) way faster than disposable income, some debtors’ are paying huge installments on mortgage debt on the one hand, and using consumer credit to finance their day-to-day needs on the other. These are asset rich but cash poor Canadians, vulnerable to all sorts of anxiety and depression.

Granted, debt finances consumer spending, which in turn, keeps the economy healthy and growing. On the other hand, imagine those financially distressed, anxious, and depressed, running to doctors or hospitals for treatment for all of their ailments arising from monetary distress and its related problems. Highly indebted are more vulnerable to committing suicide, heart attacks, strokes, consume illicit drugs to harm themselves out of sheer guilt, anger, frustration, shame, bad behaviour, keeping themselves away from work – all costing the economy in terms of both low productivity, and rising health care costs. No one knows the cost of treating debtors for ailments and suffering caused by their own actions including spending patterns.

Isn’t this an anomaly? On the one hand, we are offering credit to people, and on the other, we are paying to treat their ailments associated with financial distress brought on by their own actions. The situation is far worse for nearly two million Canadians who use pay-day lending services to finance their needs. This small proportion of Canadians is in too deep a hole to come out of it. But the society remains responsible for their health and well-being.

Need data to analyse the issue
There is an association between indebtedness and anxiety or depression. One wouldn’t know if indebtedness leads to depression or it’s the other way around as some of the depressed people may cure their depression by going on shopping, even on credit. We need some comprehensive data. Statistics Canada periodically conducts Survey of Financial Security in which it collects data on household’s components of assets and debts – besides data on its demographics, income, labour force participation, and coverage under employer pension plan. This will be the ideal vehicle to collect a bit of information on some general health issues experienced by a household (like the principal members feeling anxiety, depression, mental disorder, etc.) The regular National Health Survey conducted by Statistics Canada collects strictly health related data on Canadians. I believe it collects data on a respondent’s total income and labour force participation – but nothing on components of debts. In one survey or the other, we need to collect information on income, expenditure, health, assets, and indebtedness for a more meaningful analysis.

Tags

Anxiety   Depression   Indebtedness   Mortgage debt   Non-mortgage debt   Pay-day loan Health   Statistics Canada   Financial Security Survey   National Health Survey

Proliferation of credit cards in Canada, 1984-2014

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The six major Canadian chartered banks and other financial institutions are well aware of Canadians’ extensive use of VISA and MasterCard (MC) credit cards. According to the latest statistics published by the Canadian Bankers Association, not only the number of these cards in circulation has mushroomed from 13 million in 1984 to 72 million by 2014, the number of issuers of these cards has also jumped from 10 to 28. In 2014, there were 15 principal issuers of MCs and 13 of VISA cards.

Subsequently, the number of merchant outlets, accepting VISA and/or MC has increased 3.4 times – from 442,928 in 1984 to 1,485,147 in 2014. And, the gross sales slips issued by these merchants have sky-rocketed from 325.2 million to 3,675.6 million – an increase of 11.3 times compared to an increase of 1.5 times in the potential number of credit card users, i.e., the population 18+ (18.9 million to 28.6 million). This translates into 128 gross sales slips processed per person in 2014 compared to 17 in 1984 (Chart 1).

Chart 1_credit card_blog

The net dollar value of transactions on these cards (including cash advances) has risen from $17.10 billion in 1984 to $399.23 billion by 2014 – a 23-fold increase. Since money owed on credit cards is a part of consumer debt, no wonder, Canadians are increasing their overall consumer debt, as reported periodically, by both Statistics Canada and the Bank of Canada. Canadians seem to be in love with their credit cards. They likely use these not only to purchase goods and services, but also for convenient travel, bill payments, shopping on phone, and above all, for shopping online. The continuing growth of e-commerce is one of the key factors pushing the use of credit cards.

Sensible use of credit cards
It’s not bad to use credit cards (as a convenient and handy source of payment for any purchase in-person, or online) as long as users can repay their full balances each month. If that were the case, users won’t pay any interest to issuers, who will still make money on commissions charged to merchants selling goods on credit cards. But the reality is different. A good proportion of these card users carry-over monthly balances, likely because they don’t have sufficient funds to fully pay off their accounts, on interest rates as high as 20+%. These balances accumulate over time, putting these users deeper and deeper in the hole. These users constitute the most financially vulnerable group. Of any payment they make, a good portion of it will likely cover the interest charges. And, if they are making just the minimum payment, then almost the entire amount is simply covering the interest charges. Interest paid by these users is all that institutions need to solidify their revenue base. Those who pay off in full each month hardly contribute to this base (other than paying their annual card fee – which, again, varies with the type of card they carry). Since the interest on loans and credit cards is one of the key sources of revenue of issuers, they want to keep this financially vulnerable group as well as their peers around by further offering them various incentives, including the reduced monthly payment, periodic increases in their credit limits, allowing them to skip a payment with full interest charged – to name a few. Because it’s the interest income from this group that’s supporting other customers’ free air travel, variety of insurances, car rentals, ad-hoc rebates, cash-back programs, etc. In other words, this group is helping issuers not only to keep their other customers happy, but also in expanding their businesses.

Card issuers are not to be blamed
To be fair to card issuers, the truth be told. We live in a democratic and free-market system. Issuers are not forcing anyone to use their credit cards. It’s the user and his/her vulnerability, financial needs, impulsive shopping habits, inability to postpone a purchase, or some personal urgency, that may make him/her to use a credit card – that, too, of his/her own choice. Issuers of cards are there in the market, selling ‘money as a good at a cost’ to customers in need of their product. Issuers have to protect their money against any risk as well as earn a decent return by charging interest. On the other hand, users have the responsibility to weigh the pros and cons of using credit cards to finance their spending habits. They need to ensure about their ability to handle credit well, and within their affordability. The onus is strictly on a user to pay in full or carry-over the monthly balance. He/she doesn’t want to be labelled as ‘delinquent’, or ultimately ‘bankrupt’ (I will be writing a separate note on personal bankruptcies).

90-Day delinquency rate
The financial institutions define the fiscal year-end ’90-day delinquency rate’ as the ratio of the number of overdue accounts for 90 days expressed as a percentage of all accounts. So a user who is making just the minimum payment monthly is not a delinquent even though he/she isn’t paying any principal. No wonder, the 90-day delinquency rate has been around 1% or less with the exception of fiscal year 1990, when the rate jumped to its highest value of 1.8% (Chart 2). Keep in mind that the Canadian economy experienced a mild recession over the 1990-91 period. During the recession, those people who lose jobs and have no savings to rely on, usually depend on borrowed money – as a bridging measure. Another spike in delinquency rate of 1.3% can be noted for 2009, year when the economy just began to turn around after the recession – from late 2007 to early 2009. Technically, users who can’t pay a portion of balance outstanding should be treated as delinquent. But since the institutions care only for their interest income, they are not bothered about the time such users will take to repay their balances outstanding. Institutions simply remind users each month the time (in years and months) it will take to repay the balance if they kept paying only the minimum payment.

Chart 2_credit card_blog

What’s this minimum monthly payment?
This payment is the interest charged on the outstanding balance from the previous month plus ten dollars. Even though there are lots of calculators available on the Google site for users to calculate their monthly payment for a given amount outstanding, at a given interest rate, I am simply illustrating a case for the benefit of my readers.

Say, one owes $5,000 at 13.99% interest rate. The interest is charged daily. So the first thing to do is divide 13.99% by 365. This gives us a daily rate of 0.0383%. Now if one’s statement period covers 30 days (as usually shown on the monthly statement), then the monthly interest charged is: (5000×0.0383×30)/100 = $57.45. Add $10 to this, and you have a minimum payment of $67.45. So if one pays this amount only, then it is evident that one is simply paying the interest charge on $5,000, and just about $9 or so to pay off the balance outstanding. At this rate, a user will take closer to 500 months (or 41 years and 7 months) to pay off $5,000. That’s what the card company writes as a reminder on its monthly statement. For $10,000 balance, it will be close to 1,000 months (or 83 years and 3 months). The inclusion of this reminder, along with the rate of interest being charged on the balance outstanding, in a monthly credit card statement is mandatory in Canada. Its objective is to remind and persuade users to pay more than the monthly minimum to pay off the balance quicker.

Simply making the minimum monthly payment will leave the card user in debt forever.

Tags: VISA/MASTERCARD Credit cards Consumer debt

Minimum payment Interest on credit cards

Household debt is rising in Canada

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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).

Chart 1
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.

Chart 3

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.

Chart 4

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.

Chart 5
Chart 6

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.

Chart 7

Parting words
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).