Toronto, ON, CANADA

Cause for Concern


A new CPA Canada report shows that few Canadians are taking measures to prepare for financial shocks, despite high levels of household debt and other factors. 

Recent surveys have brought to light interesting observations about how Canadians are reacting to worrying changes in our economy. Two waves of the CPA Canada Households Public Opinion survey were conducted, one in spring 2014, the other in winter 2015. They were carried out before and after the sharp decline in crude oil prices, from a peak of US$115 a barrel in June 2014 to less than US$50 a barrel this January. The 56% decline has been due to the combination of a growing supply and weak global demand for the liquid gold.

But the average Canadian doesn’t seem too concerned. A CPA Canada report on the surveys found that Canadian households have not noticeably changed their approach to managing finances in light of the shifting economic conditions ("Household Finances: Canadians At Risk," March 2015).

The Bank of Canada, however, is very concerned. It reduced the overnight lending rate to 0.75% in January to stimulate the economy, even though it has been warning Canadians for several years that rates may go up. Bank governor Stephen Poloz recently called first quarter Canadian growth results "atrocious." Central bankers rarely talk like that, so things must be bad.

What makes the report valuable is that it doesn’t just report what Canadians say; it reconciles those perceptions with statistical measures regarding household wealth, income and debt levels. I found several sections to be of particular interest.

First, it looked at household debt levels. One area it sought input on was the effect of a specific negative shock that could occur as a result of changes in the economic environment: a decline in income. It asked respondents with mortgages to reflect on how a temporary reduction in income would affect them. Guess what percent believed that if their household income declined by 25% for at least three months they would have problems paying the mortgage? The answer is 79%. In other words, only about one in five respondents would be able to continue paying the mortgage without difficulty.

Mortgage holders were also unlikely to build wealth through paying off the mortgage. In the past three years only 28% of mortgage holders increased their payments or made lump sum contributions to pay down their mortgages faster. And only 12% refinanced the mortgage to decrease the amortization period.

The conclusion is that many Canadians are mortgaged close to the limit and are not focused on paying off this debt. As a result, many are ill-prepared for the consequences of negative economic events such as a job loss or rising interest rates.

The section on home equity lines of credit (HELOC) is also enlightening. These products are a form of "revolving" credit, requiring only interest payments and nothing toward the principal, unlike "instalment" credit such as mortgages and car loans. The survey showed that borrowing through HELOC was not widespread. Only 21% of households reported having a HELOC, and only 15% reported having a balance on it. But for those who had one, the credit limits were high: 24% had access to $50,000 to $99,999, and 34% could access more than $100,000.

There is also useful information on the debt-service ratio that shows the current ratio of interest payments to disposable income and therefore measures the cost of servicing debt and the capacity to honour debt obligations. The debt-service ratio has declined from a peak of 7.7% at the end of the recent recession to 6.9% at the end of 2014. The reason for the modest decline is essentially due to declining interest rates, which have resulted in decreased costs on variable-rate credit and lower rates upon fixed-rate contract renewals. It is not because people are reducing debt levels.

Other points of interest include provincial differences. For example, BC had the highest debt-service ratio (8.8%) in 2013 (the latest period with available data), while residents of Newfoundland and Labrador enjoyed the lowest ratio (5.3%).

The report sums up the situation: high levels of household debt mean that Canadians are vulnerable to changes in the economy, yet few are taking measures to prepare themselves for any financial shock. The report states that "this outcome may not be surprising; financial behaviours are largely driven by perceptions and, while the oil price decline may have a direct and negative impact on many Canadian households, the combination of lower gas prices and interest rates may create a feeling of greater financial comfort for others. A reality check is needed."

I couldn’t agree more. Help your friends and colleagues prepare for what might be coming — pass the report along.

David Trahair
June 1, 2015

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