What is a healthy household debt level?For the past two years Bank of Canada governor, Mark Carney, has been warning Canadians to keep an eye on their mortgage debt and avoid overextending themselves. In this age of low interest rates and increasing housing prices, it’s easy to take on more than you can afford – which is why, at a recent Vancouver Board of Trade event, he expressed some frustration that his warnings have been falling on deaf ears. “(Canadians need to) ensure that they can continue to service their debts comfortably in a higher-rate environment,” he said. Perhaps Canadians aren’t deaf as much as confused. For example, what constitutes a “higher-rate” environment? And what’s a comfortable level of household debt? Finding answers to those questions seems to be a little more difficult. Carney used a 4% real mortgage interest rate as the benchmark for a “higher rate environment”, as it’s equivalent to the average rate since 1995 (comparatively, today’s real mortgage interest rate is about 2.4%). At 4%, he says, housing affordability will fall to its worst level in 16 years. What will your mortgage payment be at a 1.6% increase? This decrease in affordability will likely lead to a housing price correction (how much of a correction depends on your area and community), since there will probably be a decrease in demand. Household debt levels will also play a role in how much buyers – and existing owners – can afford. After all, the more wiggle room you have in your finances, the more likely you’ll be able to stay in your home and keep making the mortgage payments. In the first quarter of 2011, the household debt-to-income ratio reached a record high of 146.9% in Canada. Many experts believe that an ideal number is closer to 100% -- meaning, for every dollar of disposable income, Canadians have a dollar of debt. This debt includes bank loans, car loans, mortgages and credit cards. Other experts believe we should look at the entire picture when we look at debt – including assets and income. If you’re worried about inevitable interest rate hikes, look at your household balance sheet. Can you spend these next few months aggressively paying off your credit cards? If you have a variable rate mortgage, take advantage of your mortgage’s prepayment privileges and pay down as much principle as you can now. If you’re up for renewal, maybe a fixed mortgage makes more sense for you right now. If your home is one that you can grow into – or one that you can continue living in, in case a housing storm hits – all the better.. SIDE NOTE: If you're looking for a good article on appropriate household debt levels, check out this New York Times article.    |
