Alarms went off again this week after the Bank of Canada warned household debt will likely climb this year from its already all-time high perch of 153 per cent of annual after-tax income, a worrying development since governor Mark Carney started flagging debt when it was approaching 140 per cent.
By the central bank's own projections, Canadian households are inching ever so close to the 160 per cent ceiling hit by American households before the roof caved in on the U.S. economy in 2008.
Carney and Finance Minister Jim Flaherty voiced their concerns, although they held off committing to doing anything about it.
Some analysts have expressed skepticism in the past about the central bank's furrowed brow over household debt, particularly CIBC's Benjamin Tal, who has written often that Canadian homeowners are responsible borrowers and can afford to service their borrowing.
Now two more — TD Bank chief economist Craig Alexander and Derek Holt, vice president of economics for Scotiabank — are raising their voices to try and debunk the theory put forward by Carney and Flaherty.
Yes, Canadians should be careful not to take on too much debt during the current period of low borrowing costs, but the situation has not reached alarming levels, they argue.
The myth of too much debt, they say, is that the data often cited — debt to annual disposable income — is one of the "worst" of available measures for assessing household finances, says Holt.
That's because it is comparing a liability that needs to be paid off over a lifetime to a single year's income, a bit like comparing apples and orange groves.
A better comparison, adds Alexander, would be to pit debt against assets, such a person's home equity, stock investments and other savings. If income is to be the measure, then the important criteria is the cost of servicing the debt annually, not the total debt itself.
"What truly matters is the quality of the assets acquired with the debt and even more importantly the ability of the household to meet their financial commitments," Alexander said.
He gives the example of a couple that takes out a $160,000 mortgage with a combined income of $100,000 a year. The ratio is the scary 160 per cent, but, "It is not evident that household is exposed to major financial risk," he said.
On more relevant metrics, Canadian households are well positioned.
Canadian assets relative to income is at an all-time, they have greater equity in their homes than their American cousins, and their net worth is near the pre-recession peak even though their stock portfolios are not nearly as rich. Home affordability ratios — annual cost of service debt to annual income — are also within historic levels, partly because of low interest rates.
Holt said the litmus test of the financial health of Canadian households is what happens during a shock.
Consider Toronto's 27 per cent house price slide between 1989 and 1996, or the 10 per cent drop in 2008-09. Also the 20 per cent hit in Vancouver home values between 1995 and 1999. In none of those shocks did the delinquency rate for mortgage payments approach one per cent.
By contrast, the U.S. delinquency rate hit as high as nine per cent during the current crisis.
Holt said Canadians may be more vulnerable now, but not by much.
"We have to worry about the sustainability of house price gains, we also have to worry about how much longer housing and consumer spending can contribute to economic growth, what we have less to worry about is that ... we would face a U.S.-style set of problems," said Holt.
"That's where the difference between Canada and the U.S. is night and day."
Alexander estimates a two per cent hike in interest rates would push about 10 per cent of households with debt into uncomfortable territory, where mortgage payments would eat more than 40 per cent of after-tax income.
That's something that should keep vulnerable household's eye on their personal debt curve, he said, but it does not suggest a U.S.-style meltdown is in the offing.
Analysts, including the Bank of Canada, also point out that Canadians are already starting to temper their credit appetite, since the rate of debt accumulation has slowed significantly in the past year. Part of the current climb in debt-to-income ratio is due not to taking on more debt, but to slowing income growth.Suggest a correction