Canadians Ill-Prepared for a Rate Hike; Unprecedented Debt Imminent

How to Prepare for Your Post-Debt Life-3 copy

A new report finds Canadians are facing a future where an unprecedented amount of household income will go towards debt servicing.

The Household Indebtedness and Financial Vulnerability report by the Parliamentary Budget Officer is raising concerns on the level of household debt amongst Canadians. The report suggests that debt is increasing at such a sharp pace, many Canadians will be ill prepared for even a slight hike in interest rates.

In just the first quarter of 2017, household debt reached a record level of a 174 per cent of disposable income – meaning, on average, we owe $1.74 of every $1 we make.

Since interest rates have been at record lows for so long, the PBO warns that if rates were to soon rise, “The financial vulnerability of the average household would rise to levels beyond historical experience.”

The Debt Servicing Ratio (DSR) has remained stable at 14 per cent since 2009. This means that Canadians on average use 14 per cent of their after-tax income to make mortgage payments, and pay off credit card and line of credit debt. This stat comes despite the fact that household debt increased from 158 per cent in 2009 of disposable income to 167 per cent in 2016. But the report notes that lower borrowing rates have offset the impact of this additional debt on total obligated payments.

However, this could change, for example, if the Bank of Canada raised rates from its current near record low of 0.5 per cent to three per cent. If that were to happen, the Canadian DSR would jump to a never-before-seen level of 16.3 per cent of disposable income. The highest DSR ever reported was 14.3 per cent in 2007

And after years of near rock bottom lows, the recent strength in the Canadian dollar is signaling to the Bank of Canada that a rate hike may be warranted soon.

PBO wants to provide a realistic outlook

The PBO claims that it is attempting to paint a most realistic picture of how Canadians would cope with a rate hike.

As such, the report says it is using a broader definition to define household debt by referring to the term “total financial obligations.” While many studies look at household debt separately from mortgage debt, “total financial obligations” indicates everything you owe, including debts due to credit cards, line of credits, and mortgages.

The study also looked more carefully at disposable income to understand exactly how much families have available to service their debt obligations or consumption.

What can the average Canadian do?

If you’re concerned about your own level of debt, the best thing you can do is to start paying your loans more aggressively. Yes, it sounds easier said than done, but with rates still at record lows, a lump sum payment on your mortgage or line of credit will go a lot further now than if you wait until rates rise.

If you are in the midst of renewing your mortgage, you could also benefit from a lower mortgage rate. No matter if you’re looking for a variable or fixed mortgage, can help you pay off your mortgage faster by comparing rates from over 30 brokers and lenders and providing you with the best rate on the market.

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