Household debt is now rising faster in Canada than in the United States and will continue to grow as low interest rates encourage consumers to spend beyond their means, warned a report from one of the country’s largest banks Wednesday.
The TD Economics report says Canadian debt loads have become excessive as consumers get more accustomed to easy borrowing. It adds that debt levels could continue to rise as long as the Bank of Canada keeps its key lending rate at historically low levels.
The report was released the same day Canada’s central bank warned that a strong housing market that led the economy out of recession has contributed to the highest domestic debt burdens in history. Its latest data shows the ratio of household debt to disposable income has reached 147 per cent.
But bank governor Mark Carney said he’s not overly concerned about comparisons with the United States, which he said is in far worse shape and will require more work to return to pre-recession levels.
American personal debt is in a gradual recovery mode, due to a period of deleveraging and home foreclosures. The stateside economy is also struggling with high unemployment and dismal consumer confidence coming out of the recession, which has encouraged many to rein in their spending habits and cut up credit cards.
As a result, growing Canadian debt levels are quickly coming in line with their American counterparts, the TD report found.
“The Canadian debt imbalance is currently not as great as that experienced in the U.S. and does not require a major deleveraging,” the report said.
However, “growth in personal debt must slow relative to income growth over the coming years or else the risks of a future deleveraging will increase.”
Canada’s central bank has signalled similar concerns about high debt loads and warned Tuesday that with household debt so high, it expects Canadians to spend less.
At the same time, it slashed its forecast for economic growth but held the interest rate at one per cent.
TD Bank (TSX:TD) chief economist Craig Alexander said the Bank of Canada’s decision to hold interest rates is “perfectly appropriate,” given Canada’s economic outlook and the rate of inflation.
“But the challenge is, we also have very high personal debt and as a result, we run the risk of households taking advantage of the low interest rates by borrowing more heavily at a time when finances are already pretty stretched,” he said.
The report warns that 1-in-10 Canadian households are at risk of being unable to meet financial obligations when interest rates rise. Low-income Canadians will be most vulnerable because debt eats up more of their income.
Canadians need to work to reduce their debts now while low interest rates exist and debt servicing is affordable, instead of taking advantage of it to rack up more debt, Alexander said.
“We’re trying to signal to households that they need to be careful about borrowing in a low interest environment,” he said.
“When rates come up to more normal levels, there is going to be a percentage of Canadian households that are impacted by rising debt service costs because they have taken out more leverage in recent years.”
In other words, the low interest rates have convinced many people that they can spend more than they can actually afford. A supply of credit from banks, including the easing of mortgage qualifications, gave consumers easy access to borrowing, the report found.
“Nowhere was the impact of lower borrowing costs and greater household confidence more clearly observed than in the housing market, where ownership rates increased steadily over the past two decades,” it added.
And signs for the near term show that those problems could persist as wage increases start to slow.
While debt growth is expected slow to five per cent from eight to 10 per cent in the past decade, income growth will only be about four per cent, meaning debt will continue to rise more rapidly than income.
If debt growth continues to outpace income growth, the debt-to-income ratio could rise from 147 per cent to 151 per cent by 2013, the report warned.
A more healthy debt-to-income level would be 138 to 140 per cent, meaning today’s levels are a cause for concern, but do not signal a looming crisis like that seen in the U.S. after the ratio rose as high as 160 per cent, Alexander said.