Canadians’ love affair with credit

The reasons range from static salaries to temptingly low interest rates or plain, old over-spending, but there’s no denying the severity of the problem: Canadians’ consumer debt is at an all-time high of $1.5 trillion, more than Canada’s annual gross domestic product.

In a country with a growing global reputation for sound financial services institutions and stable social conditions — at the national level, at least — a statistic like this isn’t easy to understand. But increased access to credit and high home values appear to be fuelling a national borrowing bender. Says Andrew Mayhew, who runs his own financial advisory practice in Mississauga, Ont.: “We’re seeing people take on more debt. The banks say they can afford it; and the real estate agent says, ‘You can afford it.’ But when I look at their cash flow and their bottom line, I just say, ‘How?'”

In 2005, Statistics Canada reported the debt-to-income ratio, which measures debt as a percentage of disposable income, was 116%. That number reached a new high this year — 150% — even though consumers’ ability to pay it back is not rising nearly as fast. Indeed, the Bank of Canada says that since the liquidity crisis of 2008-09, household debt has increased at a rate that is twice the rate of the increase in disposable income.

There have been some signs of improvement recently. The latest analysis of the Canadian consumer debt issue by Chicago-based credit specialist TransUnion LLC found the average non-mortgage debt load per Canadian was $25,603 for the second quarter of 2011, only a slight increase from $25,597 in the first quarter. Canadians are apparently cutting back — at least, a little — on their spending, perhaps as a result of volatile stock markets or the flat real estate sector.

Or maybe they’re just tapped out. Observes Jeffrey Schwartz, executive director of Toronto-based Consolidated Credit Counseling Services of Canada Inc. : “In the past seven or eight months, there’s been a change. It’s been going from an attitude of sticking your head in the sand, absolutely shocked, to ‘I know it’s there and now I have to deal with it.’ It’s a big leap.”

That doesn’t mean, however, that the dark cloud of debt that many Canadians are living under will be lifting anytime soon. When mortgages are added to the debt picture, the level rises to $176,461 for an average household with two children — or $44,115 per individual, according to a study by the Certified General Accountants Association of Canada. Compare this with the average family debt of $56,800 in 1990.

One of the most worrisome aspects of the debt problem is the reason that many Canadians are giving for spending much more than they earn: 57% of the CGA Canada study participants said that day-to-day living expenses — food, housing and gas — are the main culprits when it comes to their spiralling debt load. Less than 20% said the increase came from highly discretionary purchases, such as a vacation or leisure and entertainment.

Low interest rates are another factor driving borrowing. Hemmed in by relatively small increases in disposable income, or by extended periods of unemployment, many con-sumers are turning to cheap credit to bridge the gaps. That trend has the BofC governor Mark Carney concerned. In a somewhat unusual move, he has stated more than once in the past year that Canadians should not take the current low interest rate environment for granted and that they should not take on more debt than they will be able to carry when rates rise in the future. (However, recent market volatility and global debt issues are likely to prolong the current low-rate environment longer than expected.)

The sources of this borrowing binge may hold some of the answers when it comes to persuading clients to pull back. While the TransUnion study found that 24.9 million Canadians carry some kind of debt, it’s far from being just a credit card problem. Today’s average credit card debt of $3,539 per household is actually down, if only slightly, from $3,688 in 2010. In contrast, the amount owed on lines of credit, including those secured by the family home, is ballooning at an alarming rate.@page_break@Debt held through lines of credit, which the TransUnion study defines as the “aggregate balance on all lines of credit for an individual borrower, both secured and unsecured,” is an average of $33,855 compared to $32,113 the year before. That number has increased by 5.4% this year compared with 2010. According to the BofC, line-of-credit debt has doubled in the past five years, and is now accumulating at double the rate of mortgage debt.

Too often, equity in the family home is being mined to fund these loans, albeit at relatively low rates. Says Schwartz: “Canadians have been using the increase in the value of their homes as if it were a cash register. That’s been allowing them to feed their need to spend. It’s resulted in a whole lot more debt.” Partly as a result, home equity hit a 20-year low in 2010 of 34.3%.

Conventional mortgage debt is also an issue. Many Canadians are buying larger homes, giving in to the lure of multiple bedrooms and bathrooms, even though the resulting mortgages often teeter on the outer edges of affordability. According to the Canadian Association of Accredited Mortgage Professionals, average mortgage debt was $74,667 in the first quarter of 2011, up by 7.6% over the same period in 2010.

The problem is not confined to recent buyers. Although it has long been conventional wisdom that major debts should be eliminated prior to retirement, the CGA Canada study found one-third of retired households are carrying an overall debt load of $60,000, while 17% carry $100,000 or more, with mortgages making up much of that debt.

That issue may start to trend downward in the future, with property sales overall starting to slow. According to the Canadian Real Estate Association, national property sales were down in April by 14.7% compared with the same period last year, with some experts suggesting that tighter federal mortgage rules are discouraging some buyers.

Dawn Desjardins, assistant chief economist at Royal Bank of Canada in Toronto, says that other factors may also be driving the trend, including concerns that interest rates could start to rise over the next few years.

It also appears that many Canadians will carry debt for much longer than they expected. A poll conducted by Harris-Decima for Canadian Imperial Bank of Commerce released in August asked participants in different age brackets when they expected to be debt-free. The majority of respondents indicated they would reach that milestone within 10 to 15 years of their current age bracket.

Many of them are likely to be wrong. The poll also found that, while those between 25 to 34 years of age expected that they would be debt-free by age 44, only 18% of those between 45 to 54 could declare they had eliminated their debt.

Similarly, those between the ages of 18 to 24 believe they will be debt-free by age 32. Yet, not all will have an easy time achieving that goal — for many, there is the obstacle of student-loan debt. According to the Canadian Federation of Students, the average graduate in Ontario who borrows for education graduates with a debt of $37,000.

Other vulnerable groups include single-parent families, especially ones headed by older parents. According to the CGA Canada study, 83% of single parents aged 50 to 64 have debt: such families are the only age group with debt whose burden continues to increase as they age.

For many Canadians, it seems, circumstances — and not simply overspending — are driving debt accumulation. IE