An Unfortunate Love Affair

Hockey. Maple syrup. Freedom. Nature’s beauty. Whining about the weather. There are so many things Canadians love. And then there’s the thing we love the most. It’s a little something called debt. We’re positively enamoured of the stuff, just can’t get enough and savour it so much we just keep adding more.

According to a recent Maclean’s magazine article by columnist Jason Kirby entitled Canada’s Fatal Attraction to Debt, our total household debt jumped from $360 billion in 1990 to over $1.7 trillion last year, a staggering increase.

What’s causing our insatiable passion for credit? It’s easy to point the finger in several directions but, honestly, there’s one overwhelming cause: low interest rates. Looking at a graph accompanying Kirby’s article, it’s amazing how closely a rise in household debt to disposable income has mirrored a similar decrease in five-year mortgage rates since 1990.

It’s absolutely undeniable that low interest rates have led to a feeding frenzy of increased debt. Kirby says it’s like watching a movie called How Canadians stopped worrying and learned to love the debt bomb.

Despite warning after warning that interest rates are bound to rise sometime soon, most of us have grown immune to such predictions. After all, the rates have been virtually locked at historic lows for so many years, anyone who forecasts an increase is generally dismissed. As Kirby says, “We’re pretty much at the point now where it’s just accepted interest rates will stay low.”

But, betting that will happen and, consequently, that we’ll all be enjoying what Kirby calls “essentially free money” for years to come is a dangerous risk.

The columnist gives a generic example of a young couple earning $100,000 and wanting to purchase a home with a 25-year mortgage. Using the accepted guideline of not devoting more than 32 percent of your income to housing costs, the couple would have been eligible to borrow $200,000 in the days of 10 percent mortgage rates, which, although it may seem hard to imagine for some, was roughly the average rate over the last 40 years.

Instead, with rates today hovering around three percent, that same couple would now be able to borrow $300,000, 50% more than in the past. If they did, they’d be paying roughly $1,420 a month. However, should rates increase to that historic 10 percent mark, their monthly payments would balloon to something like $2,700. If you’re a new homeowner, try to imagine how that would affect your life.

And, of course, the same holds true for everything we buy. As Kirby points out, “An era of low rates has desensitized borrowers to the risks inherent in carrying too much debt. A whole generation of young Canadians has come of age in an era when no bungalow, renovated kitchen cabinets or TV is ever truly out of reach.”

There’s little doubt that the entire world’s economy is one giant house of cards. It wasn’t too long before the recession hit in late 2007 that many countries, including the U.S. and most of Europe, were considered to have booming economies that, ostensibly, showed no signs of collapse. Then BOOM!

For a few short years, there were some tough reality checks where credit dried up, houses were repossessed and much of Europe was revealed to be a virtual economic sinkhole. Then things started turning around again and – voila – people returned to their same old ways.

In Canada, due to a highly regulated banking industry and some relatively prudent government schemes, we were spared the worst of the recession’s woes and some people took a small breather from spending like drunken, financially-lobotomized sailors. But, that tendency was short-lived and now we’re pretty much back to where we started pre-recession.

The one saving mercy for all of us is that interest rates continue to hold steady, long after it was predicted over and over and over by economists and other financial geniuses that they would rise. Now, even the most rabid predictors of interest rate increases are hedging their bets, saying it could happen in 2015 or the next year or the year after that.

It doesn’t much matter. As Kirby concludes so eloquently: “Central banks have consistently proven themselves incapable of spotting bubbles. It happened in the U.S. It will happen here. And when the consensus among economists, and more importantly, borrowers, is for rates to stay low, it’s a safe bet they’ll be proven wrong. The story of Canada’s love affair with debt has all the makings of a cliffhanger, and those who’ve overextended themselves are standing at the precipice.”

Don’t miss the surprise ending to this spine-chilling thriller. I hear it’s a real shocker. Or maybe not so shocking at all.

 

 

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