Believe it or not, one in six Canadians will eventually go bankrupt.
There are just over 26 million adult Canadians, and in a typical year between 120,000 and 150,000 Canadians file a consumer proposal or declare bankruptcy, so dividing filings into population shows that over the next 30 years, assuming rates don't increase, one in six Canadians will become insolvent.
Think about that: if you are riding an elevator with six random Canadians, it's likely that one of those people has or will declare bankruptcy at some point in their lives.
Why do we have such a high bankruptcy rate? The answer is simple: debt.
We are encouraged by the government, banks, and retailers to use debt to finance consumption. According to Statistics Canada, the average Canadian has debt equal to 163.7 per cent of their disposable income. In simple terms, if you earn $20,000 (after tax) in a year, you have $32,800 in debt.
Is that a problem? Should we be worried about this?
If you are a bank lending money, high debt levels are great. Banks are earning record profits, so as long as we keep borrowing and paying our debts, the banks and credit card companies are very happy.
If you are a borrower, easy access to credit is also great, as long as you can service your payments. Debt allows us to buy a bigger house, drive a newer car, and buy fancy new electronic products. Debt creates jobs. What's not to like?
With low interest rates our average debt service ratio is at record lows. In 1990 Canadians used over 11 per cent of their disposable income to pay interest on their debt; today we only need 7 per cent of our income to pay interest. All is good.
Or is it? If we are able to handle our debt because interest rates are low, why will one in six Canadians go bankrupt? In my experience, there are two main reasons for bankruptcy even when times are good:
First, while TransUnion just reported that the average Canadian has more than $27,000 in debt, the average person filing bankruptcy owes over $60,000, not including their mortgage. You can handle a small amount of debt, but if it gets out of control, watch out.
Second, you can only pay your debts if you have an income. If you get laid off, or get sick and can't work, your ability to service your debt is gone.
I advise everyone I meet to "stress test" your finances, and ask yourself whether or not you can handle a shock to your financial system. Here are some easy questions to ask:
- Are you spending more than you earn?
- Do you have an emergency fund?
- Are you already over-extended?
All of these are indicators of how well you can weather a change in circumstances. If you are living paycheque to paycheque now, or can't survive a rate increase or loss of income, you may become one of the one in six Canadians who go bankrupt if you suffer reduced income, so now is the time to start reducing debt.
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