Economic commentary provided by Alberta Central Chief Economist Charles St-Arnaud.
Bottom line
Household indebtedness has been a significant concern and risk for the Canadian economy for some years and remains a key risk in 2024. After a sizeable improvement during the pandemic, households’ debt-to-disposable income ratio is close to its highest levels on record at 181.6%. The indebtedness ratio has improved slightly in recent quarters, mainly due to income growing faster than debt.
As a result of the increase in interest rates over the past year, the debt-service ratio rose to 15.2% from 15.1% in the Third quarter of 2023. Interestingly, despite a continued increase in the level of debt, obligated principal payments were little changed on the quarter. This is likely the result of households adapting to higher interest rates by lengthening the term or amortization period of their loans to keep their payments (interest and principal combined) from increasing too drastically. However, this comes at the expense that households will remain indebted for longer.
With indebtedness close to a record high and the Bank of Canada having increased interest rates sharply, 475bp since the beginning of 2022, there are some concerns regarding the impact of those interest rate increases on households’ ability to service their debt. The recent data shows that households are managing the increase in interest payment, but at the expense of being indebted for a much longer period. This situation suggests that, while further increases in the debt-service ratio should be expected, the extent of the rise could be smaller than initially expected.
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 on the economic outlook.
The ratio of household debt to disposable income eased by 0.3 percentage points in the third quarter of 2023 to 181.6%. This is 3.8 percentage point below the record set in 2121Q4. This means that households owe on average $1.82 in debt for each dollar earned. The small decline in the ratio in Q3 was the result of an increase in disposable income (+1.0% q-o-q), while debt increased more modest (0.8% q-o-q).
The increase in disposable income resulted from a rise in compensation of employees (+1.3%% q-o-q) and government transfers (+0.7 q-o-q). The share of government transfer in disposable income declined to 18.6% from 18.7%, 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 (+1.2% q-o-q) and mortgage debt (+0.9% q-o-q) leading the way, followed by consumer debt (+0.5% q-o-q).
Since the start of the pandemic, household debt to disposable income has decreased by 3.8pp. We estimate that if it were not for the continued rise in disposable income, the indebtedness ratio would stand at 220.9%. Conversely, if households didn’t accumulate debt over the period, the ratio would be 148.9%.
The debt-service ratio, the share of income households need to spend to repay the interest and obligated principal payment on their debt, increased to 15.1% from 14.9%. 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 (+2.2% q-o-q) as interest rates over the past year continued to pass-through higher interest debt payments. On the flip side, obligated principal payment edged slightly higher (+0.1 q-o-q). This is the first increase in principal payments in five quarters, 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 has only increased marginally (+0.3pp) compared to its pre-pandemic level. However, its composition has changed significantly. As such, the contribution from debt payments is higher by 4.0pp, with most of the increase coming from higher interest payments (contributing +4.1pp). With more borrowers renewing at higher rates, we should expect further rises in interest payments. Moreover, most of the increase is coming from mortgage debt payments (+3.2pp), while it’s almost flat for non-mortgage (+0.8pp).
On the flip side, borrowers have reduced their obligated principal by 0.1pp 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 -2.9pp.
The household saving rate rose to 5.1% from 3.7%. The higher saving rate was due to a rise in income, while consumer spending was little changed on the quarter. According to the national balance sheet data, households have accumulated about $413bn in saving since the start of the pandemic. However, the pace of accumulation is slowing. Of this amount, about $320bn is held in bank deposits, and about $bn has been invested in 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.