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Despite recently hitting record levels not seen in over two decades, the Parliamentary Budget Officer (PBO) suggests Canadian household indebtedness is actually going to rise even further in the near future.
In the first quarter of 2017, Canadian household indebtedness reached 174 per cent of disposable income compared to roughly 170 per cent in 2015, according to the PBO’s latest report published on Tuesday.
In other words, for every $100 in disposable income, households had $174 of household debt last quarter — the highest level recorded since early 1990.
And household indebtedness is expected to continue climbing over the next five years, says Mostafa Askari, Assistant Parliamentary Budget Officer.
Using economy-wide averages, the PBO’s report observes recent developments in Canadian household finances and analyzes prospects for financial vulnerability.
A financially vulnerable household requires a significant portion of its income to pay off its debt and is more likely to be delinquent in debt payments if any shocks were to occur, such as rising rates or loss of employment.
In 2018, the PBO predicts household indebtedness will rise and stabilize at 180 per cent, as historically low household borrowing rates, house prices and consumer confidence are expected to increase.
This is at odds with Statistics Canada’s latest quarterly report on the national balance sheet which said household credit market debt as a proportion of household disposable income dropped from 167.2 per cent in the last quarter of 2016 to 166.9 per cent in Q1 2017.
However, analyzing the level of debt relative to income does not provide the best indicator of a financially vulnerable household, says the PBO.
Rather, observing the debt service ratio (DSR), which is household debt payments expressed relative to disposable income, paints a better picture.
In the first quarter of 2017, for every $100 in disposable income, households had $14.20 in debt payments which includes interest plus required principal payments, according to the PBO.
But with a projected rise in household indebtedness, the DSR is expected to increase as well to 16.3 per cent by the end of 2021 — 3.5 percentage points above the long-term historical average of 12.9 per cent.
“Households are paying a larger proportion of disposable income to service their debt, so that means essentially their vulnerability has increased,” says Askari.
There’s no benchmark DSR at the national level to determine a high or low ratio, but observing the historical average can provide an outlook of the state of household vulnerability.
“The level that we have seen now is much higher than the historical average which is about 12.9 per cent,” says Askari.
“So that by itself is an indication that we are getting into the areas where we have to be worried a little bit about this,” he adds.
The PBO predicts effective interest rates on mortgage debt will rise from 2.9 per cent in Q1 2017 to 4.8 per cent by the end of 2021.
However, if interest rates were to rise even higher, many households would be left struggling to service their debt.
“If interest rates rise beyond that, what we are projecting right now, then you will see suddenly that ratio will rise significantly for some households and then they could have some challenges meeting their debt obligations,” says Askari.