Concerns over household debt in Canada are overblown

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Appeared in the Financial Post, July 18, 2017
Concerns over household debt in Canada are overblown

With headlines like "Canadian household debt levels hit a record high" and dire warnings from top policymakers such as Bank of Canada governor Stephen Poloz, many Canadians may think household debt is out of control.

The concerns, however, often fail to properly account for the other side of the balance sheet. Yes, Canadian households have taken on more debt over time. But they have used this debt to finance assets—real estate and retirement savings, for example—that grow over time, causing their net worth to swell, also to unprecedented levels. More on that in a moment.

By the end of last year, household debt eclipsed $2 trillion, up from $357 billion in 1990. The lion’s share of this debt (two thirds, in fact) is for mortgages while the remaining third is split between consumer credit (29 per cent) and other loans (5 per cent). Moreover, despite the pre-occupation with overheated real estate markets, the mortgage share of total household debt has remained stable. The $2 trillion-plus in household debt now equals approximately 170 per cent of household disposable income compared to just 90 per cent in 1990.

So does this mean Canadians are being irresponsible with debt? The short answer is no.

For starters, the above data ignore that the growth in household debt has partly been a rational response to plummeting interest rates. For instance, the Bank of Canada rate has fallen dramatically from nearly 13 per cent in 1990 to 0.75 per cent at the end of last year. Perhaps not surprisingly, as the cost of borrowing has dropped, Canadian households have borrowed more.

The drop in interest rates has been so significant that the interest burden of servicing debt has declined as a share of income, despite growing household debt. Today, interest payments on household debt consume 6 per cent of disposable income compared to almost 11 per cent in 1990.

Which brings us back to the other side of the balance sheet—household assets. While household debt has grown substantially over the past 26 years, households are borrowing to invest in appreciating assets such as real estate, pensions, financial investments and businesses. In fact, Canadian household assets rose dramatically from $2.2 trillion in 1990 to $12.3 trillion in 2016.

The significant investment in assets has meant that household net worth (which is total assets minus liabilities) surged from $1.8 trillion to $10.3 trillion, a record setting level, during the same 26-year period. As a share of GDP, household net worth rose from 265 per cent to 498 per cent. While government policymakers fret over household debt, the irony is that unlike government, household net worth is positive and increasing over time.

In the end, debt is a tool and the concern should be not with debt per se but debt that's not manageable given the economic circumstances the households face. The greatest risks to management of household debt are a) economic shocks that lead to job losses that make it harder for people to service their debt and b) increases in interest rates that raise debt-servicing costs.

To date, even with any small forecast increases, interest rates remain low and the Canadian economy has performed adequately in terms of employment with relatively low unemployment rates. Moreover, while these macroeconomic factors are of concern, they should also be kept in context. Despite record high levels of household sector debt, there are also record high levels of net worth.