Economic commentary provided by Alberta Central Chief Economist Charles St-Arnaud.
Bottom line
Households are slowly deleveraging as higher interest rates change the attractiveness of debt, with debt-to-disposable income reaching its lowest level since 2015 if we exclude the pandemic. The indebtedness ratio has improved slightly in recent quarters, mainly due to income growing faster than debt. Nevertheless, at 176.4%, household indebtedness remains elevated and a significant concern and risk for the Canadian economy.
Despite higher interest rates in recent years, the debt-service ratio eased slightly to 14.9%, on par with its pre-pandemic level. The lower debt-service ratio is mainly the result of higher income compensating for the higher debt payments. However, it is important to note that debt payments are increasing much less than the interest rates suggested. This results from households adapting to higher interest rates by lengthening their loans’ term or amortization period to keep their payments (interest and principal combined) from increasing too drastically. However, this comes at the expense of households remaining indebted for longer. With indebtedness and interest rates remaining high, this pattern should remain in the coming year, as many mortgage borrowers have to renew at higher interest rates.
As mentioned, households are already reducing their principal payments to offset the pressures from higher interest payments, easing the negative impact on their budget. This is also evidenced in the sharp rise in proposals (renegotiation of terms) in the insolvency data, which are not above pre-pandemic levels. However, as we have shown (see Will it be a hard landing or a soft landing? The labour market will decide), a shock on household income as a result of job losses would lead to a surge in insolvencies and have a significant impact on the economic outlook.
The ratio of household debt to disposable income eased by 1.6 percentage points in the first quarter of 2024 to 176.4%. This is 9.0 percentage points below the record set in 2021Q4. This means that households owe on average $1.76 in debt for each dollar earned. The decline in the ratio in Q1 was the result of an increase in disposable income (+1.8% q-o-q), while debt increased more modest (0.9% q-o-q).
The increase in disposable income resulted from a rise in compensation of employees (+1.5%% q-o-q) and government transfers (+1.2 q-o-q). The share of government transfer in disposable income eased to 18.5% from 18.6%, still slightly above its pre-Covid levels.
On the debt side, the increase in total household debt was due to a rise in all categories, with non-mortgage loans (+1.3% q-o-q) and consumer debt (+1.1% q-o-q) leading the way, followed by mortgage debt (+0.8% q-o-q).
Compared to pre-pandemic, household debt to disposable income has decreased by 4.8pp. We estimate that if it were not for the continued rise in disposable income, the indebtedness ratio would stand at 224.9%. Conversely, if households didn’t accumulate debt over the period, the ratio would be 142.1%.
The debt-service ratio, the share of income households must spend to repay the interest and obligated principal payment on their debt, eased slightly to 14.9% from 15.0%. This means that, for each dollar earned, households need to spend $0.15 to service their debt.
The details show that the rise in debt payments resulted from an increase in the interest payments (+3.1% q-o-q) as higher interest rates continued to pass-through higher interest debt payments. On the flip side, obligated principal payment declined (-1.3 q-o-q). Obligated principal payments have been on a declining trend since 2022Q1, as a greater share of fixed debt payment on variable rate debt has been redirected away from principal payment to cover the increase in interest payments and households restructure their debt on longer maturity.
The debt-service ratio is roughly unchanged compared to its pre-pandemic level, despite interest rates being significantly higher and debt level having increased. However, its composition has changed significantly. As such, the contribution from debt payments is higher by 4.5pp, with most of the increase coming from higher interest payments (contributing +4.7pp). With more borrowers renewing at higher rates, we should expect further rises in interest payments. Moreover, most of the rise is coming from mortgage debt payments (+3.4pp), while the increase is more modest for non-mortgage (+1.1pp).
On the flip side, borrowers have reduced their obligated principal by 0.2pp since pre-pandemic, despite debt levels having increased over the period. This situation shows that households have managed to absorb the cost of higher interest rates at the expense of extending the maturity of their debt.
The continued growth in disposable income helped hold back the debt-services ratio, contribution -3.5pp.
The household saving rate rose to 6.9% from 6.2%, its highest level since 1996, if we exclude the pandemic. The higher saving rate was due to a faster rise in disposable income than in consumer spending over the period (+1.8% q-o-q vs 1.2% q-o-q). According to the national balance sheet data, households have accumulated about $434bn in savings since the start of the pandemic, with most of the savings going to equity and investment funds.
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Independent Opinion
The views and opinions expressed in this publication are solely and independently those of the author and do not necessarily reflect the views and opinions of any organization or person in any way affiliated with the author including, without limitation, any current or past employers of the author. While reasonable effort was taken to ensure the information and analysis in this publication is accurate, it has been prepared solely for general informational purposes. There are no warranties or representations being provided with respect to the accuracy and completeness of the content in this publication. Nothing in this publication should be construed as providing professional advice on the matters discussed. The author does not assume any liability arising from any form of reliance on this publication.