Managing personal debt
July 3, 2014
There are early signs that Canadians are starting to better manage their personal debt. That is a benefit to all Canadians including those with no debt.
Over the past several years the high level of personal debt we have carried has posed a risk to all Canadians.
Think of the Canadian economy as a small village where the actions of some affect everyone. Financial mismanagement in the form of excessive debt will hurt some and that pain will likely spread to others.
The condo market in Toronto is a good example. If buyers stretch their financial limit to buy a condo, what is the risk they take on if interest rates increase?
Those who could barely afford to pay the high-interest costs of a large mortgage will now face even higher carrying costs when their mortgage term ends and they face an interest rate increase. Many will be forced to sell.
Prices will decline when there are more sellers than buyers. Any decline in condo prices will likely lead to a decline in single family houses. That will result in fewer houses being built or renovated.
Less activity in the labour intense housing market could cause unemployment. That would harm other areas of the economy as unemployed workers with less money in their pockets reduce their spending. Economically everything is connected. A decline in one area of the economy can quickly spread to other areas.
Information released in June by Statistics Canada shows there is positive news that Canadians are finally beginning to better manage their excessive debt.
Total household debt had only a slight increase of 0.4 percent; the lowest in four years. Over the last 12 months household debt increased 4.2 percent which is the lowest in the past 12 years.
Mortgage debt accounts for close to two-thirds of debt. Consumer credit represents close to 30 percent of debt. This percentage should be your focus if you have debt.
Interest rates on overdue accounts can be 20 percent per year or higher. A good suggestion for those with debt is to pay down this most expensive debt as soon as possible.
The good news for us all is that the rush to maximizing debt has slowed down. The bad news is that individual Canadians and the Canadian economy are still exposed to the risk of high debt levels.
A good way to measure debt is to look at the relationship between the amount of household debt to disposable income. It is the income that allows you to pay interest costs of carrying debt.
The ratio of disposable income to debt is close to an all-time high which tells us that many Canadians are at the upper limit of being able to afford their debt.
If interest rates increase, the arithmetic of balancing a family budget will be impossible for those who cannot increase their income enough to pay these higher interest rate charges.
The reality check for Canadians includes many things. First, there are an unprecedented number of firms that want to offer you credit. Some of those companies make far more on the credit financing than they do on the actual sale of a product or service.
Second, is the current low interest rate, a tempting trap that lures you into thinking you cannot possibly refuse such attractive financing for items that you likely do not even need to purchase.
Debt needs to be repaid at some point and quite often with interest.
Our strong recommendation is to continue the encouraging signs of slowing down the use of debt. We will all benefit from your actions.