What to do about our debt

Everyone knows that Canada’s got a debt problem, but it seems to be getting worse. On September 11, our debt-to-income ratio rose to a record 164.6%, up from 163% in March. It was the biggest quarter-over-quarter jump since 2011.

While more pressure on our personal balance sheets is never good — especially for retirees, who are becoming increasingly more indebted — our collective leverage may also be bad for our economy, which could ultimately impact our retirement savings.

Canada’s economy is already struggling with lower oil prices, but Mark Hopkins, a senior economist with Moody’s Analytics, thinks that our debt levels are a big problem.

“The concern is always that if you have a high debt-to-income ratio, it becomes unaffordable,” he says. “Then you have more risks to worry about.”

The main concern is around housing debt, which accounts for about 80% of our total household credit. This applies to retirees, too — an Equifax Canada survey, released on September 14, found that mortgage debt among those aged 70 and older has increased by 12% over the last two years, while people over 65 owe an average of $142,000 on their homes, up from $126,000 in 2013.

The first problem is that asset prices could fall, so retirees who bank on the profits from a house sale could get less than they had planned for. The second issue is that rising rates would make variable-rate mortgages more costly and harder for some people to pay off.

If people are overextended, they’ll cut back on spending and that could have a negative impact on our economy. In 2008, Canada rebounded so quickly because we had money to spend.

“And that’s one of the biggest risks around the elevated debt-to-income ratio,” says Hopkins. “We had a willingness to spend even in the face of falling incomes during the recession. Now that debt has been racked up and that cushion doesn’t exist.”

“Overall, it’s not healthy,” adds Stephen Lingard, senior vice-president and portfolio manager with Franklin Templeton Solutions. “We don’t see an imminent crash, but with the resource slowdown, there are a lot of headwinds for the Canadian economy right now.”

At the moment, our debt-to-interest ratios are low, meaning that people can pay off the interest they owe. If this technical recession becomes a more pronounced downturn — and most economists don’t think that will happen — and people lose their jobs or incomes decline, then it could get harder for people to pay off what they owe.

So what does this mean for your clients? Of course, the first thing they should be doing is paying down their debt, especially any high-interest loans. If someone’s income falls because they’re not working anymore then, naturally, that debt will be harder to pay off.

When it comes to investments, though, advisors need to be careful about putting their client money into one sector in particular: Canada’s banks. With people already carrying so much debt, loan growth is slowing, says Lingard. He thinks earnings forecasts are too rosy for the sector and valuations are too high.

That might be tough for retirees who rely on dividends for income — and it can be a good idea to use company payouts to pay down debt — since many own banks. An advisor may want to shift those financial sector dollars into less economically sensitive, but still good dividend-paying, companies.

It’s also a good idea to watch your clients’ bond exposures, so that an eventual interest rate hike doesn’t hit them in two places at once. As rates rise, those bond prices will fall, but a hike could also make line of credit and mortgage debt more expensive. If housing prices do come down, then portfolios will get hit in two ways: lower bond prices and lower real estate prices.

Most investment experts suggest sticking to short-term fixed income products — they’re less impacted by falling prices and can be rolled over into higher-interest bonds more quickly than long-term instruments.

At the moment, all of this is more of a wait-and-see game than a we-should-panic-now problem. While Canadians overall are increasing their debt loads, defaults are low, meaning that people are making their payments. Get your clients under control now and you won’t have to worry if things really do take a turn for the worse.

“I don’t think we’re in a recession now, but there is a high risk for one,” says Hopkins. “The high debt levels aren’t a crisis on their own, but if there is a shock to the economy, we won’t be able to spend our way out of a recession and, ultimately, our own net worth could be impacted.”