INDEPTH: PERSONAL FINANCE
Buy now, pay later: Canadians and debt
by Tom McFeat, CBC News Online | September 12, 2006
Buy now, pay later – Canadians and debt
On the surface, the problem seems big, dangerous, even out of
control. We're talking about Canadians' ever-growing affair
with debt. Getting into it. Trying to get out of it. And then
piling on more of it.
Personal bankruptcies are near record highs. In 2003, for the
first time ever, the average Canadian household owed more than
its annual take-home pay. We carry 74 million credit cards –
three for every Canadian over the age of 18. Credit counselling
agencies say they're busier than ever. Students are often graduating
with accumulated debt of $25,000 or more. Consumer debt levels
are rising much faster than incomes and have been for years.
Savings rates are at record lows.
So that's the bad news. Or is it? Are we truly facing a debt
crisis, or can we handle it?
Obviously, that depends on the amount of debt we have, the repayment
terms we've agreed to, the interest rates we're charged, and
our income. But it also depends on the kind of debt we have.
For one thing, financial planners like to distinguish between
good debt and bad debt.
Good debt versus bad debt
You may think all debt is bad. But some debt is considered much
better to have. Good debt is used to buy things that tend to
increase in value (like houses or stocks). Those hard assets
can be used to secure the debt so you'll pay less interest.
And interest on money borrowed for investment purposes (like
a rental home or mutual funds outside of an RRSP) can be tax-deductible,
making the effective interest rate even lower.
Quick Fact:
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47 per cent of all Canadian households spent more than their pre-tax income in 2001.
Source: Statistics Canada
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You can also make a good argument that borrowing to go to college
or university is good, if painful, debt because you will make
more money in the long run as a graduate.
Many financial advisors also say borrowing to contribute to
an RRSP is considered a "good" debt, especially if it's paid
off within a year.
Bad debt, on the other hand, is used to acquire things that
depreciate in value (cars, clothes, big-screen TVs) or for day-to-day
personal consumption. That makes most credit card debt bad.
And bad debt is never deductible.
Many financial advisers also advise consumers to distinguish
between needs and wants (beware the impulse buy) and to ask
questions every time they're about to take on a significant
new debt. Do they really need that new plasma TV or luxury vacation?
And do they really need to charge it?
Do they really need to borrow every mortgage dollar that the
bank says they can? What would happen if they lost their job?
And what if mortgage rates were three percentage points higher
in five years' time?
So how much debt is too much?
Anyone who's applied for a mortgage knows there are strict guidelines
banks use to judge the ability of someone to handle a six-figure
loan. The monthly mortgage payment must not be more than 32
per cent of the applicant's gross monthly income. And total
monthly debt payments including the mortgage cannot come to
more than 40 per cent of gross income.
Quick Fact:
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Percentage of Canadian credit card holders who are
not aware of the interest rate charged by their main credit
card company:
41 per cent
Source: Financial Consumer Agency of Canada
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But with the increasing use of lines of credit and credit cards,
people can easily end up with monthly obligations that pinch
the financial waistline. And debt-servicing costs assume that
you're paying the minimum required to service the loan or credit
card. Borrowing to the max can leave little wiggle room in the
event of a job loss. Or if interest rates start to rise.
All the experts agree that if you're having trouble making even
the minimum monthly payments on your debts, then you need help.
More on that later.
The evidence also shows that credit grantors will often give
people who are in debt up to their eyeballs even more credit.
They'll bump up credit limits without being asked. They'll approve
new credit cards for someone who already has six. Simply put,
do not expect a company that is in the business of lending money
to look after a borrower's best interests. That's the borrower's
job.
Are we vulnerable to rising interest rates?
Vulnerable? Definitely. Is it a big problem? Well, that depends
on who you listen to. There's no question that today's low interest
rates have helped to fuel a major spending binge, especially
on housing. Low rates have also anchored those double-digit
increases in home prices across most of the country recently.
And they've helped Canadians manage all that new debt. But mortgage
rates have begun to creep up recently. And some experts see
potential trouble ahead for a populace that's in hock up to
its neck.
Quick Fact:
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Average amount owed by bachelor's degree grads who
left school in 2000 with student debt:
$19,500
Source: Statistics Canada
|
Scotia Capital economists say that while we, so far at least,
generally seem to be managing our debt successfully, rising
interest rates do pose a longer-term risk for the economy. They
point out that Canadians increasingly are picking variable rate
mortgages, which move up in lock step with prime lending rates.
So do lines of credit, which have also ballooned in popularity.
The Scotia Capital report estimated that a one-percentage-point
increase in the average effective interest rate over five years
would boost debt servicing costs as a share of after-tax income
from the current 7.5 per cent to nine per cent – a level
that in the past has led to a drop in discretionary spending.
But that's the macro picture. What about the individual Canadian
borrower?
Surveys show that paying down debt is still the number 1 financial
goal for most Canadians. Most say they will try to pay down
their debts in the coming year. But for a minority of Canadians,
that just won't happen. That's unfortunate, because paying down
debt should be a priority for everyone. And the higher the interest
rate, the faster it should be tackled.
And for most people, there's no debt with a higher interest
rate than the one attached to their well-used credit cards.
In this series on credit and debt, we'll look at how to manage
one's debts, how to check your credit rating, what to do when
debt trouble looms, and how students are coping with crushing
debt burdens that can take 10 years to conquer. We'll start by looking at credit cards.
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