Updated: Household indebtedness hits near record high, but may not be all bad news

The health of Canadian balance sheets unexpectedly deteriorated in Q3 2018 according to Priscilla Thiagamoorthy, economic analyst with BMO capital markets. 

Canadian household credit burdens crept higher contrary to expectations. The country’s debt-to-disposable income ratio climbed to a near record high of 173.8%, growing from 173.2% in the prior quarter.

However, unlike in previous quarters, the growing debt-to-disposable income levels is the result of weaker income rather than rising debt levels. Net worth as a percentage of disposable income has fallen to its lowest levels since Q3 2017, falling continually each quarter. While income levels have fallen so has the amount of credit. Canadian indebtedness fell mildly in Q3 2018 as credit growth slowed to a 35-year low.

“While the decade's long consumer debt mania is finally easing, income growth now remains a concern, keeping household credit burdens a key headwind to the Canadian economy,” said Thiagamoorthy in a note to investors.

Falling incomes and rising interest rates don’t exactly mix. As a result, credit payments are starting to take a bigger bite out of Canadians’ paycheques. Debt principle and interest payments as a percentage of disposable income hit 14.5%, their highest levels since Q2 2018, the height of the Global Financial Crisis. This means that 7.2% of income is required to make interest rates, the highest levels in seven years. 

Despite households requiring more income to pay off loans, Trevor Tombe, economist at the University of Calgary, highlights that a deeper look into the numbers shows that Canadians are actually spending less on interest and more on debt principal. 

"Now the fraction of income going to principal is roughly the same as the amount going to interest payments," said Tombe. "Historically, the amount we spend on interest is much much more than the amount we spend on the principal, so thats another sign of improving household debt service ratios" 

However, not all the data presented today is bad news. Tombe points to rising financial assets as a sign that the high debt-to-disposable income ratios aren’t as concerning as they may seem. As a result of Canadians increasing their holdings of financial assets, the debt-to-assets ratio has remained relatively stable for the past two decades. Tombe also highlighted that net debt-to-income ratios have fallen significantly over the long term despite remaining mostly stagnant for the past few years.

Net debt is household debt minus liquid assets that could be used th pay off that debt. Rising financial assets have caused net household debt-to-income ratio to plummet over the past two decades from roughly -175% in 1990 to roughly -375% in 2018. 

Tombe points out that wealth, measured as financial assets minus debt, is rising.

"As households become wealthier and hold more assets, then debt will grow with it, that's normal," said Tombe. 

He used the example of mortgages to explain. As the value of a house rises, so does the debt along with it. This suggests that as long as assets and wealth are increasing as well, the rising debt levels are not a cause for concern.

Tombe elaborates this data seems to show that household debt isn't at a crisis point, at least not in the aggregate. More detailed data about the debt levels of households at different points in the income distribution is needed to determine whether Canadian households are at a crisis point when it comes to debt.