This article was originally published in Maclean's Magazine on December 6, 2004
Canadians' Personal Debt at Historic Level
RUSSELL KENT learned earlier than most about the allure and the pitfalls of credit - he was 14 when his father gave him his first credit card. Each month the bill would appear on the corner of his dad's desk; Kent was expected to attach receipts for purchases he'd made during the month, and the cash to pay for them. "If the receipts or the money weren't there, my dad would freak out," recalls Kent, 32, who requested his name be changed for this story. "If the bill was for $19.78 and I clipped a $20, the next day there would be 22 cents on my dresser." His father's message was stern and unequivocal: don't buy anything you don't have the cash to pay for.
It's a philosophy Canadians lived by for generations, but these days it's not an easy mantra to follow. As interest rates drifted to the lowest levels in decades, consumers responded by buying everything from homes and cottages to cars and appliances. The shopping spree has fed a healthy cycle of economic growth and a robust job market - but we've gone deep into hock to pay for the good times. With every drop in interest rates, the definition of living within one's means changed - with financing like this, you too can afford a luxury condo! The notion of buying only what you could easily pay for became a meaningless principle.
And so this summer Russell Kent and his wife, Mary, joined the legions of other young families in opting to ignore the admonitions they'd heard from their parents and taking the plunge into homeownership. They bought a house in the suburbs north of Toronto - and in the process have run up their debts far above anything they'd ever imagined. The house cost more than the top amount they'd intended to spend. They had to drain much of their savings and load up on personal lines of credit to muster a 25 per cent down payment. In total, they now owe roughly $340,000, spread across a mortgage, three lines of credit and two credit cards. Every month, $920 goes to pay interest on the cards and bank lines, and another $1,460 toward the mortgage. Mary also spends $300 a month to lease her car. Debt payments eat up close to a third of their after-tax income. Russell says making ends meet over the next few years will be "like stretching a gnat's ass over a rain barrel."
If the Kents feel intimidated by the debt challenge ahead of them, they're not alone. Collectively, Canadian consumers now owe $752.1 billion, according to Bank of Canada, up 36 per cent in the past 10 years when adjusted for inflation. Over the same period, personal disposable income, or take-home pay, has risen 15 per cent. In other words, Canadians are piling on debt more than twice as fast as their income is growing.
While the debt surge has been mainly attributed to rock-bottom mortgage rates fuelling runaway house prices, the numbers suggest a stampede into real estate is only part of the story. At the end of 2003, Canadians held $517.7 billion in mortgages. That's the lion's share of all consumer debt, but as a percentage, housing debt represents a smaller portion than it did in 1995. Meanwhile, typically more expensive forms of borrowing, such as credit cards and personal credit lines, have become a much bigger part of Canadians' debt burden.
All of this has been affordable because low interest rates have kept payments on our myriad loans in check. But rates are now on the rise, and there are serious questions about how soon Canadians will start to feel the squeeze of their debt-financed comforts and indulgences.
To some it seems we've lost the discipline of planning for a rainy day. "As a society we have become addicted to low interest rates," says Benjamin Tal, senior economist at CIBC World Markets in Toronto. "That means as consumers we're much more vulnerable to an economic shock, like a sudden rise in interest rates, a recession or a job loss. Many of us are now living paycheque to paycheque."
This vulnerability is best illustrated by the steady decline in the savings rate over the past two decades. In 1985, the average Canadian socked away 15.8 per cent of his take-home pay. It was that savings cushion that allowed this country to bounce back from economic disasters like the 1987 stock market crash and the 1990 collapse of the residential real estate market. A decade later, the savings rate had slipped to 9.2 per cent of after-tax income. By 2003, the average Canadian saved just 1.4 per cent of his pay.
There are lots of theories about the sociological impulses driving our love affair with credit and our ambivalence toward saving for tomorrow. Are they the logical extensions of our consumer culture? A timeless desire to keep up with the Joneses? Or is it just that the ideal of middle-class stability - a house, a car, kids - is moving further out of our financial reach? Mary Kent says she grew up wanting a house with a yard and trees - the kind of place she was raised and in which she could raise her own family. As she approached her 30s, she became willing to do whatever it took to achieve that goal. "When I walked into this house, I thought, 'I could be happy here forever,'" she says - and wanted it even if it meant stretching her resources to the limit.
But there are consequences to taking that kind of leap. Early this year, The Vanier Institute of the Family sounded the alarm with a report on the state of Canadian family finances, entitled "Living on the Edge." The study highlighted several worrying trends, such as a 20 per cent drop in average contributions to Registered Retirement Savings Plans between 1997 and 2002, and the fact that household spending continues to outpace income growth. "For far too many, the 'edge' is getting closer and closer," the report's author, Roger Sauvé, concluded. "A growing number will fall over the precipice when, and not if, interest rates begin to rise from their 40-year lows. Households need to rein in some of their spending, pay off some debt and build a bigger cushion against slower times. The time to act is now." The implication: Canada is facing nothing less than a crisis in financial planning.
For now, Sauvé's dire outlook puts him in the minority. Despite the sobering picture presented by the statistics, most economists reject any talk of a ticking debt bomb. Derek Holt, an economist at RBC Financial Group, says that fears over rising debt levels have been blown out of proportion, and that the stats underestimate consumers' ability to adjust to changing circumstances. In a March report, he sought to debunk several myths about household finances, including the notion that North Americans are taking on too much debt and saving too little.
Holt argues that the rising value of household assets - thanks especially to buoyant real estate prices - have largely offset ballooning debt. In both Canada and the United States, the vast majority of borrowing has been plowed into tangible investments rather than simply blown on pricey restaurants and expensive clothing. As for the record-low savings rate, Holt contends that rising house prices, together with the appreciating value of investments in retirement plans, are a form of saving because they serve to grow people's nest eggs. Once you take into account this often overlooked fact, he says, Canadians come out looking in much better shape than his gloomier colleagues suggest.
Adrienne Warren, an economist with Scotiabank, agrees, and adds it's not debt size but debt affordability that is at issue. Back in 1995, interest costs ate up 9.2 per cent of the average person's annual take-home pay. Last year, those costs were down to just 7.7 per cent. As long as interest rates rise gradually, Canadians should be able to easily afford their current debts, Warren says.
But there is one key assumption that underlies the confident case outlined by Holt, Warren and others: they all project that economic growth, job creation and real estate prices will remain roughly as healthy as they've been recently, or that any changes will happen slowly. Not everyone is convinced. CIBC's Tal, for one, fears that because Canadians have piled up debt like never before, even small changes in the economy could hit them hard.
For example, many people have spent the past couple of years feeling wealthy thanks to those rising house prices and low financing rates. And when you feel rich, you tend to spend like you're rich. A good number have gone out and borrowed against their homes to renovate, or buy a cottage, or start a business. The trouble with this so-called "wealth effect" is that it can cut both ways. "Real estate prices can fall and you're still stuck with the debt," Tal says. Although he doesn't expect a sharp drop in the real estate market, a levelling off of prices could slow all that home equity borrowing, and leave people feeling nervous about their levels of debt, he says. That, in turn, could further constrain spending, reversing the cycle of economic growth.
Tal worries about the financial shocks that can strike without warning. Like hurricanes, they're hard to predict, yet they occur with regularity. And when consumers are building their financial plans, they'd do well to prepare for the unexpected.
The economic storm winds haven't even begun to blow - growth remains healthy and interest rates are still relatively low despite recent hikes - and yet there are already signs that more Canadians than ever have pushed their borrowing beyond what's manageable. There were 84,297 personal bankruptcies in 2003, up 52 per cent from a decade earlier, and 2004 is on pace to break that record.
Given all that, it's no wonder people are growing concerned about what will happen when interest rates climb higher. Earlier this year, a Maritz Research poll for Manulife Financial found that almost three-quarters of those polled had made little or no progress paying down their debts in the previous year, and 68 per cent expressed concern over the impact that rising rates might have on their finances. Another poll conducted by CIBC in July suggested that if mortgage rates climb back to the 10-per-cent range seen in the mid-1990s, the majority of homeowners would be hard-pressed to keep up with their mortgage payments.
Most economists don't foresee a return to those interest rate levels in the near future, but it's a prospect that keeps at least some Canadians from sleeping well at night. Mary and Russell Kent can certainly identify with that worry. They have the house they always dreamed of. They both have steady, well-paying jobs. And they have a solid plan to get out from under their debt. But when she looks at the mountain they have to climb, Mary admits she finds it daunting. "It's heavy-duty," she says. "I don't want to say it's unmanageable, because we're managing it and we're going to manage it. But it's heavy-duty." Russell agrees, but tries to sound a reassuring note. "My focus for the next few years is debt reduction. First my credit card, then Mary's. Then my lines of credit, then Mary's. It's going to be tight - and it'll take two or three years to do it. But we will do it."
See also CONSUMER CREDIT.
Maclean's December 6, 2004