Debt threats

Credit-loving Canadians are finding themselves increasingly in hock. It's not a crisis yet, but warning signs are plentiful

MONTREAL – Guylaine Houle looks at a big screen television differently than many.

She's a bankruptcy trustee.

She's seen too many of those televisions - bought on credit - go from being hours of joy to months of anguish.

The owner had to have the latest thing, complete with all the bells and whistles, and jumped at one of those deals where you buy now and pay later - maybe 14 months down the road. But they didn't save toward paying off the set when the bill came due. So 14 months later "it's no longer a magical TV, it's a payment."

Houle and David Solomon, another local bankruptcy trustee, said misuse of credit, buying things on time when you really don't have the money to pay for them, is a key culprit behind the increasing number of miserable people showing up at their doors.

Emily Reid, a personal financial counsellor, wishes they would do away with the word credit. "Credit is a positive word for something that is really a liability," she explained. You are not getting credit, she said, you are renting somebody else's money, and it's going to cost you.

It is true Canadians are going steadily deeper in debt. Statistics Canada's debt-to-income ratio, which measures the average debt-load as a percentage of disposable income, has risen steadily in recent years to 145.01 per cent in the third quarter of 2009. That figure includes all debts, including mortgages.

It is also true that most Canadians are in better shape than their neighbours in the U.S., where the rate is 151.7 per cent, and, for the most part, Canadians are managing their debts.

Still, just before Christmas, Mark Carney, governor of the Bank of Canada, issued an alert. Though healthy now, the risks to household finances are increasing, he said. "Aggregate debt level has risen sharply relative to income."

Doug Porter, deputy chief economist with BMO Capital Markets, agreed with Carney's alert.

"I don't think debt is a huge problem yet, but it's definitely on the cusp of becoming an issue, especially given the fact that interest rates are almost certainly going to go up, if not over the next year, then certainly the next two years."

Carney was cautioning "against overdoing it in the middle of what is obviously a very strong housing market," Porter said.

For a home buyer, rate increases mean hefty payment boosts. For example, if rates go to 4.5 per cent from 3.5 per cent, the National Bank says monthly payments on a $150,000 mortgage will rise $82, from $748 to $830, assuming a five-year term and a 25-year amortization.

The lion's share of the debt in Statistics Canada's debt-to-income ratio is in mortgages, Porter said, and over the past year mortgage and credit card debt have risen about seven per cent, while disposable income has risen 1.6 per cent.

With the rise in house prices and the prospect of higher interest rates increasing the cost of carrying those houses "I think we're stretching the envelope of affordability," Porter said. He suggests people planning to buy now consider avoiding the uncertainty of variable mortgage rates and look to a five-year term.

And they also shouldn't count on their house escalating in price in the near term.

He expects prices to moderate toward the middle of the year, particularly as an increase in new home building puts more properties on the market.

It would appear Canadians are being careful. A study released this month by the Canadian Association of Accredited Mortgage Professionals showed that the vast majority of the 40,000 mortgages it surveyed were fixed-rate mortgages with terms of three years or more.

While the majority are coping, there is evidence that the economic downturn has sent a minority over the edge in larger numbers.

Figures released Thursday show that for the 12 months ended Nov. 30, 2009, personal insolvencies rose 34.1 per cent in Canada compared with the same 12-month period in 2008. In Quebec, they rose 23.7 per cent.

In human terms, that means 112,535 people nationwide and 33,498 people in Quebec, found themselves in deep trouble.

An insolvency can be one of two things - a bankruptcy, where the person cannot pay their debts; or a proposal, where the person works out a deal to pay off their creditors, often not paying the full amount, or taking longer to do so, or a combination of the two.

Across Canada, bankruptcies were up by 32.4 per cent during that 12-month period, while proposals were up 40.2 per cent. In Quebec, bankruptcies were up 23.3 per cent and proposals rose 25.6 per cent.

There was a very significant jump in September, because the government made bankruptcy rules tougher on people, Solomon said, so folks rushed to get in before the changes came into effect. And it's not surprising to see the numbers climb during periods of rising unemployment, he added.

"A lot of young people are going bankrupt as a result of not finding work in their field after they graduated from school. Some have student loans and the banks are harassing them," he said.

"They have no income or little income and are using their credit cards to cover their cost of living, hoping to get a position some day that will enable them to pay."

They end up with half a dozen credit cards and run up to the limits.

Solomon said every person who walks through his door is a different story. Occasionally he encounters people who can not carry their home because they have lost their jobs. But mostly he sees people who are spending more money than they have.

Houle agreed that unemployment is often the trigger behind a bankruptcy; so is divorce. But the person might have been heading toward the brink for sometime, she said.

It's a societal thing, she said.

"People want to be rewarded now, and the credit society has allowed us to do that," she said, even though many can't afford those rewards.

Reid agreed. The under-40s have grown up in a world where everybody uses credit cards, she said, and people have come to think that because they are working, they buy what everybody else buys.

But they are acting like employees, not managers, she said. A manager has a plan. He knows how much money he has and what he can afford.

Houle said that if she had her way, the education system would introduce consumer courses at an early age.

A budget is so important, she said, but 75 per cent of the people who come before her have never done one. Those that did were following an example set by their parents. So getting in the habit will not only help you, but your offspring as well.

People also have to understand what terms like compound interest mean and how it can push your debt load higher, she said. Compound interest is the interest that is charged on interest. If you do not pay your bill in full one month, the next month you will be charged interest on the unpaid principal plus the accumulated interest.

Reid said understanding interest is key. Clients often tell her they have been making the minimum payment on their credit card bills, she said, but they don't realize that at that rate, paying off those debts will take years. After you subtract the interest, very little of that minimum payment went on the principal, she said.

Reid said the best advice she can give is: "If you find yourself in a hole, stop digging." Then spend only on what is absolutely necessary, and don't rent other people's money to do it.

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Debt-to-income ratio in Canada

Canadians are going deeper into the red. Their debts exceed their disposable income.

3rd Quarter

2004 120.49 %

2005 125.35 %

2006 128.52 %

2007 133.73 %

2008 138.55 %

2009 * 145.01 %

* Last quarter for which 2009 figures are available

Source: Statistics Canada

smcgovern@thegazette.canwest.com