01/24/2014 08:01 EST | Updated 03/26/2014 05:59 EDT

How's Your "Debt Psyche"?

In the financial media, January is the month often coined the 'debt hangover' with many people feeling the winter blues while trying to reconcile how they will service their holiday bills and increasing debt loads. The 'debt psyche' that results for many during this period is often one of a heightened aversion to assuming more debt. Given recent news in the media, however, one may wonder how our collective debt psyche will respond in the face of current economic events.

Of particular interest in this speculation is the impact recent cuts to mortgage rates will have on our debt psyche. On January 18th, the Royal Bank of Canada cut its fixed-rate mortgages by 10 basis points. As many predicted, other Canadian banks quickly followed suit with the Bank of Montreal (BMO) and Scotiabank both dropping their fixed-rate mortgages on January 21st by 10-20 basis points.

What was curious about these rate cuts was the manner in which the banks did so. All banks reduced their rates quietly, without press releases or media fanfare (not the norm when banks are lowering rates and making it 'easier' for consumers to borrow). In speculating why the banks would do so, our debt psyche comes to mind, as does the federal Finance Minister's warning to Canadian banks back in March 2013.

That warning last March was on the heels of BMO cutting its five year fixed-rate mortgage to 2.99 per cent. Finance Minister Flaherty sternly advised Canadian banks that his expectations were that they would "engage in prudent lending -- not the type of "race to the bottom" practices that led to a mortgage crisis in the United States."

With the recent rate cuts by the banks, one may speculate that they wanted to avoid a repeated reprimand from the Finance Minister. Once may also speculate that they appreciate the mixed message these rate cuts send to consumers and our collective debt psyche.

That mixed message is a concern. After all, Canadians' debt-to-income ratio is at an historic high. The Bank of Canada and Finance Minister have been warning Canadians for some time about their growing debt loads and the significant risk those represent when interest rates eventually rise above their current, artificially low, levels. Indeed, the Finance Minister interceded into the mortgage market over a year ago specifically to make it harder for Canadians to take on additional (mortgage) debt.

The Bank of Canada and our Finance Minister seem to be aware of our collective debt psyche when providing these warnings and taking these steps. They seem to be aware that our collective debt psyche has encouraged many Canadians to amass ever increasing debt loads due to the extremely low interest rates in place during the post-recession, stimulus period. They are also certainly aware that the recent lowering of mortgage rates creates a mixed message, promoting additional borrowing by consumers at a time when the government is encouraging the reduction of personal debt.

But the mixed message inherent to the recent mortgage cuts is not limited to the fact it encourages consumer borrowing while governments encourage debt reduction. The rate cut also sends a mixed message to consumers about what direction interest rates are going. The cut may lead many to believe the low interest rate environment is here for a longer period than it may actually be and our debt psyche may take comfort in such a notion.

But this suggestion is not consistent with many financial authorities. A recent Reuters poll of 37 economists had them unanimously agree that interest rates will rise by 2015. This was consistent with international authorities, such as the OECD, which has called for the Bank of Canada to raise rates by 2.25 per cent by the end of 2015. Likewise, the IMF has stated interest rates will rise, but not until 2015 and not to the same extent. Even our own Finance Minister suggested in early January that Canada will be pressured in 2014 to start raising interest rates.

As of writing this, however, the Bank of Canada did not raise rates at its January 22, 2014 policy meeting. Concerns over deflation are involved in this decision to hold rates neutral. But this failure to raise rates does not contradict what the experts are saying and should not lead our debt psyche to take comfort in the debt loads many are carrying. Interest rates will rise. It is not a matter of 'if' but of 'when. When they do, debt servicing will become a problem for many.

As such, the current cut in mortgage rates should not alter a January austerity, or any focus on debt reduction that may stem from it. Letting complacency enter into our financial planning, based on a comfort level of servicing debt in a low rate environment, could be hazardous to many in the near term. Perhaps the best use of the remaining low interest rate environment is to devise a plan to consolidate debt at lower rates, if at all possible. It may not be as attractive as a home renovation, new car or trip south, but it may be the best medicine for January's debt hangover.