Rising household debt not an issue, RBC argues

(August 12, 2005) More Canadian households are beginning to manage their debt and finances in the same way corporations do, say RBC economists, by using lines of credit and other relatively new ways of borrowing to smooth incomes over the course of their lifetimes.

This growing reliance on lines of credit and similar products is often misread as a sign that households are grossly mismanaging their finances, aided by the current low interest rate environment, say RBC economists Derek Holt and Ivana Rupcic.

But while they admit there are pitfalls associated with the range of financing options available today, they say the annual pace of household debt growth today is lower than it was in the 1970s and 1980s, and overall borrowing patterns today are not excessive.

In their report — The Rise of Household Inc. — Holt and Rupcic say lines of credit are increasingly replacing installment loans in the consumer debt arena. Lines of credit also appear to be growing at the expense of residential mortgages and some credit card debt.

“The rapid increase in the popularity of lines of credit has led to the false perception that today’s pace of growth in household debt is breaking historical records. This is simply not true, despite generation lows on interest rates,” say the authors. Part of this “false alarmism,” they add, comes from the fact that debt is currently growing faster than incomes. “Although true, it is a little late in the game to make such an observation. Annual debt growth has been running ahead of income growth for decades.”

While it’s hard to say if consumers are actually conscious of the move, Holt and Rupcic say low and stable inflation rates are giving clients the ability to plan over longer time periods, with greater certainty, than in previous environments where highly volatile swings in inflation and borrowing rates were the norm.

They say these developments, along with a wider range of financial products and generally higher levels of comfort in dealing with debt products, are simply allowing households “to use new instruments to better smooth their income and consumption over their lifetimes.”

This trend, if the authors are correct, will have interesting implications, especially in the area of financial planning. RBC maintains that if households use credit to smooth their spending patterns, it could in turn be assumed that wealth accumulation patterns will also be affected.

“Instead of a gradual run-up in wealth to peak levels prior to retirement in a classic model that has wealth accumulators giving way to wealth preservers and decumulators, shifting future earning power to the present through debt markets and postponement of liabilities may well mean that the pace of wealth accumulation is faster and sooner in life and slower later on.”

Although some will find the report problematic as it virtually condones carrying higher levels of debt as an acceptable way of life, the truth of the matter is consumer debt products are not going to go away any time soon. The authors say there is room for more financial innovation through the introduction of a greater variety of structured household lending products, but they also point out, in several places, that more options and greater flexibility will require individual prudence and sound advice from financial institutions about the suitability of different products.

Filed by Kate McCaffery, Advisor.ca, kate.mccaffery@advisor.rogers.com