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Households with elevated levels of debt are more vulnerable to increases in interest rates. With interest rates on the rise, highly indebted households could see their increased required payments exceed their budgets. The increased debt payment burden may come at the cost of reduced consumption, decreased savings or opting to make lower repayments on principal amounts. Some households might even default on their loans if their incomes are not sufficient to cover higher expenses and credit charges.
If an increasing number of borrowers begin to default on their loans, financial institutions may decrease lending activities in response. These negative effects could then impact other areas of the economy. Research has shown that recessions in highly indebted countries tend to exhibit a greater loss in output, higher unemployment, and last longer compared to countries with lower debt levels.
Household debt to disposable income near record levels
The debt-to-income (DTI) ratio is a measure of the relative vulnerability of indebted households. While households may be able to service their debt during periods of low interest rates, some may face challenges when rates rise. Highly indebted households have usually few debt consolidation options to respond to increasing debt service costs.
Total household debt relative to disposable income has been trending higher as indebtedness has been rising faster than incomes, with mortgage debt being a major contributor, counting for two-thirds of all outstanding household debt in Canada. While the increasing trend in the Canadian DTI ratio has now paused, it remains near a record high, hovering around 170% in Canada and varies significantly among Canada’s metropolitan areas (see chart 1). Vancouver and Toronto have the highest DTI ratios in the nation, at 242% and 208%, respectively. Thus, the DTI ratio in Vancouver is more than double the level in Saint John (106%).
While the DTI ratio in Canada has not changed much over the last 9 quarters, that is not the case for all centres. Significant year-over-year percentage point changes have occurred in Edmonton (-8.3), Calgary (-7.9), Hamilton (5.9) and Victoria (4.2). The drops in Calgary’s and Edmonton’s DTI ratios were driven by income growth, as total debt levels only decreased slightly. For Hamilton and Victoria, DTI ratios increased as a result of strong growth in mortgage debt and installment loans.
