I sat down with Scott Satov, CEO, Loans Canada for his insights on the rising debt profile and decreased spending power of Canadian households,as well as the impact - in dollar terms - the Bank of Canada's upcoming rate hikes will have on individual finances.
Ketki Saxena: Hi Scott. It's good to have you here. Thank you for joining us
Scott Satov: Good to be here, Ketki. Thanks for having me.
Ketki: So Scott, let's get right into it. So far this year, the Bank of Canada has raised rates five times from their extreme lower bound of 0.25% to 3.25%. In this period, we've also seen total household liability rise by approximately 70 billion. Could you tell us a little bit about the household debt profile of Canadians? What’s the breakdown in terms of different types of debt?
Scott: Sure. As everyone knows, there's an obvious rising debt scenario in Canada, and it's creating havoc for a lot of households. Right now, the Canadian household debt to income ratio is 182%, which basically means that for every dollar that an individual earns, they owe 82 cents. That rate is up from 180% in the second quarter. On the debt side, the average consumer in Canada has about $21,000 in household debt, and you have to also add in some mortgage debt.
Mortgage debt per person is about$ 75,000 per person. Now if it's a two-person home, that would be $75,000 times two, which is $150,000. You add their other consumer debt, $21,000 times two people. So you're looking at almost $200,000 in debt per household. The increased rates and the high housing prices have increased the mortgage load in Canada up by 185 billion, which is the largest jump in more than a decade.
Ketki: Given that we're seeing debt skyrocket, how is the spending of Canadian consumers being affected? Because we're not just contending with rising rates, we're also contending with sky-high inflation.
Scott: Yes, people are obviously feeling these things in their pocketbooks. Most people have less disposable income after paying off all their debts. Some of the information we saw is that 49% of Canadians have appeared to change their saving and debt behaviors given the high inflation and the high debt situation.
In a way, that's a good thing. People are not in a bubble. They see what's happening. But I guess what I'm questioning is whether it's too late or whether they’ll be able to change the course of their financial future.
Ketki: And this huge decrease in affordability is expected to worsen. Not just because there will be more rate hikes coming up from the Bank of Canada, but because the existing rate hikes haven't fully been priced in yet. Could you tell us a bit about what type of debt has been affected already, what has yet to be affected. By when can we expect the rate hikes to be priced in to existing debt?
Scott: That's a good question. Ketki. So you have to break down debt between variable and fixed rated. Variable mortgages, just like their name implies, will vary quickly depending on the Bank of Canada. Fixed debts will lag depending on their term. So for example, if you have a five year car loan, it'll remain the same for now.
But when you go to get a new car after five years, your new car will be effectively much higher than that. And that also goes for credit card debt, which is also fixed. The fixed debt catches up in the next cycle. It depends on which type and when the cycle rolls over - for example, credit card debt is quicker. Some types of mortgage debt is fixed, so that will catch up depending on what period the interest rate is fixed for. For example, 5 years is the period most common in Canada.
Ketki: We talk about interest rates and basis points as abstract numbers. Could you give us a sense of what this looks like as a real world impact on consumer finances? Given that interest rates are now expected to be at 4.25%, by year's end, what kinda pressure does that put on Canadian consumer debt? For example on an average mortgage, which is for $600,000?
Scott: Yeah. $ 600,000 of debt, at 3.25% with a 20 year term is $3,400 a month. And if your interest rates rose by a hundred basis points to, let's say 4.25%, you'd pay about $3,700 and change. So basically about 350 more dollars per person per month.
That's the difference of payment on only a 1% increase, which is a hundred basis points.
Ketki: Do you think Canadians will be able to handle these rising mortgage payments and higher interest rates, because so many Canadians are struggling with debt right now. And what advice would you have for Canadians in that position?
Scott: So the reality is, that there's going to be much more defaults. Certainly a lot of Canadian consumers will be affected and adversely affected. If there was 2% defaults two years ago, because of the higher debt payments and the inflation environment, it'll be more than that. Maybe it's three or four percent.
In terms of Canadian consumers dealing with debt, the best thing to start off with is to have financial literacy to understand what their debt looks like. Understand which debts you have, which are fixed, which are variable. In an inflationary environment where debts are going up quickly, you should try to pay off those variable debts as quickly as you can, and take advantage of your fixed debts because those won't change for a certain amount of time.
And line up your debts . Figure out the highest debt that you have, the most variable, the most affected. And pay that down.
And of course, start budgeting. Back to basics. Understanding your budget is the most important thing. And also living by your budget, which is not easy, Some people could budget really well, but it’s really hard for them to give up certain things that they're accustomed to. So it's really about perseverance and how focused you are on the goal, and your discipline to get there.