BMO's recent decision to lower its mortgage rates and potentially trigger yet another mortgage price war among Canadian banks led to Finance Minister Jim Flaherty cautioning banks not to engage in a "race to the bottom" with rates.
This has triggered a debate among analysts and commentators about the merits of debt -- one outlining this week why "it's a great time for Canadians to be in debt".
It's true that with interest rates so low and unlikely to rise anytime soon, the opportunity cost is skewed in favour of taking on more debt. However, it's important to distinguish between productive debt and frivolous debt and to consider the impact of various types of debt on consumer and business credit scores and future borrowing ability.
The fact that interest rates are low and consumers and businesses may have access to effectively "free money" only matters in the context of the use of that debt. Racking up debt to go on vacation, buy expensive toys or fund a lifestyle is the type of frivolous debt that Finance Minister Jim Flaherty has been cautioning against because it is that debt that has no clear way of being repaid and will weigh on the borrower when interest rates do inevitably rise.
I'd like to believe the only kind of debt anyone might encourage Canadians to actively take on is productive debt. I agree that given the low interest rates available, it does make financial sense (only for those that can truly afford it) to borrow in order to invest in productive assets. With blue chip stocks yielding dividends of 3-4 per cent and stock markets achieving record highs, borrowing to enhance a stock portfolio can make sense (although careful consideration needs to be paid to this type of investing to ensure you can truly afford this).
Now is a great time to buy that new piece of machinery or otherwise invest in your business using cheap debt. Incurring debt to invest in productive assets when interest rates are low, so that you can achieve financial returns far in excess of interest costs, while maintaining a clear path to repay the debt makes perfect sense.
The type of debt is also a critical variable in the borrowing equation. Asset-based debt, whether real estate, equipment or personal assets (like jewellery or precious metals), could be considered "good debt" because it is either used to 1) fund productive assets (in the case of mortgages funding real estate as a long-term investment or equipment to produce more "stuff" to sell) and/or 2) does not impact credit scores (like personal asset loans).
On the other hand, credit card debt or cash flow debt (like an unsecured line of credit) can be considered more problematic because the ability to repay that debt is more dependent on the interest rate and employment environment. As a result, the potential negative consequence to credit scores, and therefore future borrowing ability, is real and significant.
In the current low interest rate regime, debt can be great, but only if used prudently for the right reasons. Canadians should not view the availability of cheap debt as an invitation to binge because the hangover will be excruciating.
Steven Uster is the Founder of Zillidy, a Canadian private alternative lender that provides personal asset loans secured using jewelry, luxury watches, gold, diamonds and precious metals as collateral. Zillidy's loans provide a line of credit without impacting credit scores or requiring the sale of valuable or sentimental assets.
