Statistics Canada – Credit Scores and Debt Servicing Costs Make Debt Paying Easy
Canadian household debt increased slightly, with household borrowing mostly driven by Mortgages, while unsecured debts, such as credit cards and personal lines of credit, decreased slightly. Despite the rise in household debt, overall leverage remained low compared to several years ago. This balance was particularly evident in the amount of new credit card debt added to the existing household credit. Debt-to-income ratios in the range of 30% of income are usually indicative of high levels of debt.
The recent global financial crisis resulted in a sharp contraction in Canadian credit. Although the decline in credit is generally narrowing, there is still a lot of potential for further economic contraction in the coming quarters to come. As a result, Canadians are still very exposed to debt-related risks. In this article we will review two recent trends that have been important contributors to household non-mortgage loans that were mainly driven by the recent recession in the United States.
One of the factors that contributed to household debt rose in the second quarter of 2021. This was the first time that rising oil prices have raised household income since the global recession began. Real crude oil added about three cents to the dollar on a monthly basis in the second quarter. This has made oil a more practical option for many families to buy fuel for their automobiles.
Another factor that likely contributed to the recent rise in canadian household debt relates to changes in the composition of Canadian employment. Most Canadian employment has been supported by benefits and pensions. Most of the increase in employment is therefore directly attributable to workers switching from employment that is associated with defined benefit plans to employment that is not so closely tied to these plans. If the number of workers leaving employment without benefits increases at the same time as the number of new workers entering the labour force increases then the ratio of disposable income to potential disposable income will increase.
These two factors, which are based on varying trends in the employment rate and the rising availability of benefits and pensions, resulted in higher levels of household borrowing relative to disposable income. The ratio of debt to disposable income climbed as the cost of borrowing increased relative to income levels. At the same time, interest rates were cut by the Bank of Canada reducing the long-term interest rate it has stated it would keep until the end of the recession in the third quarter of this year. The cuts to interest rates are expected to increase borrowing rates across the country.
In the third quarter of this year the unemployment rate will likely be revised upwards by the Bank of Canada. If it is increased by half a percentage point the ratio of debt to income would rise yet again. If it is increased by one percentage point the ratio will be flat with the unemployment rate. With the combination of lower interest rates and higher inflation there will be less room to make debt-to-income before the economy starts growing out of its recessionary mode.
The combination of lower interest rates and higher inflation will mean that Canadians will have more money in their pockets to spend. Households will be able to make debt servicing costs equal the gross domestic product (GDP) rather than the debt ratio. For some, the combination of lower interest rates and higher inflation means that they will be able to pay off their debts faster. For others, the combination of higher inflation and lower interest rates will mean that they will be able to pay their debts sooner.
Statistics Canada’s latest figures on the Canadian economy show that over the last six years, Canadians were more confident with their credit scores as opposed to the previous five years. Over the last two-year period, the level of confidence with credit scores improved for all Canadian demographics except for people over the age of sixty-five. This is interesting because over the past five years, the number of seniors that were relying solely or primarily on their credit cards to make ends meet dropped dramatically. This is good news for the average Canadian who has the option to pay their bills on time through credit cards. The combination of a high disposable income ratio and low interest rates and higher inflation will mean that Canadians will not be paying off their debts as fast as they did in the past.