The Elephant in our Living RoomsApril 29, 2010
Canadians expect the federal government to live within its means. What is true for government is also true for households (Statistics Canada defines a “household” as a person or a group of people living in the same dwelling. Households include retired couples, childless couples, individuals living on their own and the traditional nuclear family). Canadian household debt has risen rapidly in recent years. Data from Statistics Canada shows the debt-to-income ratio for Canadian households has increased from 90% only twenty years ago to over 144% in 2009. In other words, the average Canadian household currently owes over $144 in debt for every $100 of disposable income. That compares with the federal government’s debt-to-GDP ratio (debt-to-national income ratio) of 44% in 2009. These high levels of household debt suggest that many Canadians will struggle to make debt payments when interest rates inevitably rise. While many Canadians are rightly concerned about the federal government’s debt, Canadian household debt may be the bigger problem.
Many are unaware of the risk that rising interest rates present. While the cost of borrowing is at an historic low, there is nowhere for interest rates to go but up. The increase in credit card debt and the assumption of increasing mortgage risk indicate that many do not understand the fundamentals of finance. That is why our government established Canada’s Task Force on Financial Literacy which will support initiatives across Canada aimed at improving financial education.
Anyone who has read the small print on a credit card contract will know that credit card fees and interest rates are difficult to understand. That is why our government has introduced the Code of Conduct for the Credit and Debit Card Industry to make it easier for consumers to understand fees and interest rates. The Code of Conduct will require advance notice of any new fees or fee increases. Should fees rise or new fees be added, the Code of Conduct stipulates that the consumer can withdraw from the contract without penalty. Financial institutions will have till May 17th to adopt this Code of Conduct. By making it easier to understand fees and interest rates, consumers can make better decisions about the debt they incur.
While a lack of financial literacy and the need for more transparency are concerns, unsustainable levels of household debt are the real problem. Quite simply, Canadian households have taken on too much debt, and most of it is mortgage debt. Household debt is the elephant in our living rooms. While we escaped the housing crisis south of the border, we must be cautious and learn to live within our means. That is why our government introduced new mortgage rules which require borrowers to qualify for a five year fixed rate mortgage even if they wish to borrow on a variable rate. The new rules also require a minimum downpayment of 20% for real estate purchased as an investment. Finally, the maximum loan-to-value for those who wish to refinance their homes will decrease from 95% to 90%. These rules are intended to prevent vulnerable consumers from a taking on an unsustainable debt burden.
Canadians expect their government to live within its means. It is equally important for Canadian households live within their means. As the pioneers who settled Wellington and Halton Counties used to say, watch the pennies and the dollars will take care of themselves.
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