Canada’s Household Debt Ratio Is Climbing Once Again, Here’s Why It’s A Problem

Canadian household debt problems were in retreat, but they’re back and even stronger. Statistics Canada (Stat Can) data shows the household debt to income ratio (DTI) climbed in Q2 2022. It follows a reduction in the previous quarter, when income outpaced credit growth. High (and rising) DTIs typically lead to reduced consumption, and a rise in unemployment.

Household Debt To Income Ratio 

The household debt to income ratio (DTI) is the average share of credit to disposable income. Household credit is mostly mortgage debt, but also includes things like credit card debt. Disposable income is a household’s income after mandatory transfers, such as taxes. More simply put, if the DTI is 180%, households owe $1.80 for every $1.00 they take home in income.

Higher ratios are bad and lower ratios are good, like you’d probably assume. Since debt is borrowing your future income and economic activity, lower use is good. Owing $1.80 for every $1.00 you earn might not sound like much, but keep in mind it’s an average. Only a third of households have a mortgage, and typically it’s much smaller than today’s buyers.

Debt is also concentrated in higher income households. Despite the narrative, highly indebted households aren’t typically low income. Low income households have larger hurdles to obtaining significant debt ratios. It’s one of the oldest and weirdest misconceptions in society. But anyway.

Higher DTIs reduce a household’s flexibility to respond to economic shocks. Having access to a HELOC to tap in an emergency mitigates risk. Tapping it for a hot tub and having to pay it back in an emergency? That tends to compound your risks.

The now seminal work on household debt explains this concept very clearly. NBER researchers Mian and Sufi studied US leverage in 2006. They found an increase in leverage relative to income led to reduced consumption. After all, they had to repay the debt they just loaded up on. Reduced consumption led to a rise in unemployment a year later. Since households loaded up during the best economy, they had little room to borrow in the worst. This made the ability of monetary policy to help them extremely limited.

Canadians Owe $1.82 For Every $1 They Take Home

Canada’s household DTI climbed once again last quarter. Stat Can reported a ratio of 181.7% in Q2 2022, up 2 points from the previous quarter. Households owe $1.82 for every $1.00 they take home, once again keeping in mind that this is an average. 

Canadian Household Debt To Disposable Income

The quarterly ratio of outstanding consumer credit to household disposable income.

Source: Statistics Canada; Better Dwelling.

The ratio is lower than the all-time record, but it’s within spitting range. The highest DTI was reached in Q4 2021, when interest rates were still at a record low. Households had just borrowed so much cash with low rates, they hit a record. In Q1 2021, the ratio made a sharp decline as credit slowed borrowing and incomes gained some ground. However, the rising ratio in the most recent quarter implies credit growth outpaced income growth.

“…subsequent tightening is expected to weigh on mortgage demand and slow the pace of debt growth in the coming quarters,” said Shelly Kaushik, an economist at BMO. 

Rising rates diverted a bigger share of payments to interest instead of principal. At the same time, higher rates also reduce borrowing and encourage repayment. Further tightening in Q3 (and probably Q4) are likely to slow borrowing more. On the upside, the labor market is still robust and can cause the ratio to fall. At least in the meantime.

4 Comments

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  • Reply
    Stressed Out 6 days ago

    Dan,

    Your last sentence could reference the point (maybe by way of a footnote), that the labour market just took a large step backwards. Look at the jump in the Canadian unemployment rate last month!

    Pretty sizeable leap.

    And the problem is that inflation is affecting many global economies. So rates have to continue going up (like in the US) and if not, our currency will drop, reemphasizing higher inflation (unless we want to buy $15 cauliflower).

    Large indebtedness is tying our hands. We’ve borrowed from the future and we’re heading into a period of weaker growth because the deadload is getting far more expensive and people will start to pay that down, siphoning off expenditure money.

  • Reply
    Gui 6 days ago

    I fear Canada is in the path of becoming the new Spain when it comes to a housing and economy crash.

  • Reply
    JM 6 days ago

    I don’t think the Canadian Income levels have been updated yet to take into account the end of CERB and CRB and other government handouts that significantly raised the income level the last two years. Once Income levels lose those gains as well as the potential recession hitting, this % will probably hit record highs around 190% by Q1/Q2 2023. I hope I’m wrong but that’s what it looks like

  • Reply
    Ike 5 days ago

    This should be great for inflation reduction –> interest rate tapering –> house price explosion.

    Party on again?

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