Canada is currently in the midst of a gigantic debt problem, at least according to personal finance nerds and other general non-YOLO types. Do I even need to point out these same people also hate 99.2% of fun?
Budgets are fun! they say, lying worse than Bill Clinton about that time he gave it to a unnamed secretary in the kitchen of the White House. TOPICAL.
According to the latest numbers I could find after 6.3 seconds of Googling (or, as we in the Financial Uproar editorial department call it, PAINSTAKING RESEARCH), Statistics Canada says at the end of 2015, our collective debt-to-disposable income ratio grew once again, increasing to 165.4% compared to 164.5% the quarter before.
This means that for every dollar in disposable income–which is gross income minus taxes, CPP and EI contributions, and any other mandatory deductions–the average Canadian owes $1.65. That’s up approximately 65% since 1998, when the percentage owed first hit 100% of disposable income.
This trend is concerning for a number of reasons. Pro-equality folks say the increase in debt is caused by bigger problems, namely the ever-growing gap between the rich and the rest of us poor schmucks. The so-called 99% is poorer than ever, they assert, because incomes for average folks have barely stayed pace with inflation.
Housing bears think our growing debt load is going to eventually cause the mother of all housing collapses. All that’s needed is a few rate hikes or a huge wave of unemployment or some other bad thing and it’ll cause the whole house of cards to finally collapse. Try to resist the urge to punch these folks when they all but gloat when you lose your house and possibly your dog.
And even if the housing market manages to have the so-called “soft landing” we all fantasize about, most financial crises happen because of debt. The last one in the United States was caused by mortgage debt. Other ones happened because of Russian debt or Argentinian debt or Southeast Asia debt.
So, yeah, it’s pretty easy to say debt is a bigger problem than that time I got my head stuck between stair railings. Pro tip: BUTTER DOESN’T WORK.
Personal finance folks think there’s one and only one solution to this problem–you pay down your debt, stupid. For the most part, they’re collectively okay with folks financing stuff like an education, car, or house, but draw the line at expensive consumer debt.
Some are so anti-debt they insist on paying for everything with cash, including the inevitable time when they decide to buy a house.
The world gets divided into two camps. The first is the regular guy who wants to have the nice things he sees everyone else enjoy. Instead of saving up for said thing, he finds somebody to finance it. For a reasonable interest rate, he gets to enjoy a car/education/whatever without the associated pain of saving up for it.
The second camp is the one who thinks you should save up for stuff before you buy it.
In our world, the first camp gets crapped on a lot while the second camp gets praised harder than a dog when it finally pisses outside. We all agree minimizing debt is a good thing.
But the more I think about it, the more I think the folks leveraging up their own balance sheets aren’t nearly as dumb or shortsighted as we think. Here’s why.
A great time to consume
One word can be used to describe Canada’s economy since the ol’ 2008-09 meltdown.
I was going to go with tepid.
Look at you, smart writer guy.
NOW WHO’S IMMATURE.
Because the economy still isn’t great, interest rates have stayed low. They’ve bounced around a little bit, before falling to the point where a five-year fixed mortgage can be had for under 2.5%. That’s pretty low, and I barely know how to count.
When rates are low, folks are encouraged to borrow. That’s the whole point of lowering rates in the first place. Low rates help to make things more affordable which then encourages people to consume. This new consumption hopefully stimulates the economy.
In short, shouldn’t we expect people to increasing their borrowing during times of low rates?
Canada’s debt-to-disposable income ratio has been steadily increasing over the last three decades as interest rates have fallen. If you look at both graphs there’s definitely some major correlation. So, yes, debt is going up. But it’s became steadily easier to service that debt.
Let’s look at an example. Say you made $60,000 in 1998 and 2016, ignoring inflation. After taxes your disposable income is say $30,000. Back in 1998 say you could borrow money at 8% compared to 3% today.
So in 1998 you’d borrow 100% of your disposable income of $30,000 for a debt of $30,000. At 8% annually you’d be on the hook for $2,400 per year in interest.
In 2016 you’d borrow 165% of your disposable income of $30,000 for a debt of $49,500. At 3% annually you’d be on the hook for $1,485 per year in interest.
So even though the amount owing is 65% more, interest payments are still 38% lower.
Say both people paid $300 per month towards their debt. 1998 guy would take 165 months to pay back his loan (13.75 years) while 2016 guy would take 213 months, a full four years longer.
But when we look at total interest paid, a different picture emerges. 2016 guy pays $14,405.24 in interest to pay off his outrageously long loan. 1998 guy actually ends up paying far more in interest, paying $19,602.39, even though his loan is shorter.
The point is simple. Low interest rates pay off for people who are in debt longer.
Penalties for abusing credit
This brings me to another point. I firmly believe the penalties for abusing credit are, at worst, merely an annoyance.
As we all know, borrowers have a few actions they can take if they take out too much debt. They can call the creditor directly and negotiate. They can keep up payments just enough to ensure a lender doesn’t take them to court. Or, if things get too bad, they can always declare bankruptcy.
Let’s focus on the bankruptcy part. Without going into too much detail, here’s what happens.
- You list your creditors to your bankruptcy trustee. Unsecured creditors get nothing unless there are assets left over
- Secured creditors who have collateral are usually not listed in the bankruptcy case. If they are, usually they just get their security back.
- A certain amount of home equity is exempt from the process (in Alberta it’s $40k)
- Your credit is ruined
As I’ve argued more times than I can count, I believe it’s very possible to live a life without credit.
Look at it this way. What’s stopping you from getting a big car loan and about six different credit cards and then declaring bankruptcy after charging them up? All you’d need to do is exclude the car loan from the bankruptcy and that’s it. You’re in business.
You can live life without credit. You’ll pay a little higher rates for car insurance or whatever, but that’s not the end of the world. You can get around the whole not having a credit card thing by signing up for your bank’s secured Visa.
So what’s your punishment for abusing credit? Worst case scenario is bankruptcy which is annoying, but isn’t the end of the world.
Prevalence of credit
In 2016 it’s easier to get credit than ever.
Need a new credit card? No problem. There are 10-15 major credit card issuers in Canada and probably about 50 minor ones. I’m sure one will be happy to give you a card to spend on smokes and hookers.
Need a mortgage? There are hundreds of different banks, credit unions, and non-bank mortgage companies all competing for your business. And if they all say no, you can always go to the world of private lenders.
Need a car loan? My experience in the industry says that Ford, GM, or Crysler’s credit divisions say yes to just about everyone. It’s only a matter of the rate you pay.
Have too much credit card debt? No problem. Places like Grouplend (now called Grow) or Borrowell will do a debt consolidation loan for just about anyone with a heartbeat and a half decent credit score.
If you’re looking to buy some sort of big ticket item, it’s almost a guarantee the business selling it to you either has its own financing program or one backed by a big finance company. And if that loan doesn’t do it for you, shop around. Trust me, you can find someone to lend you the cash.
In short, if you can finance it, chances are there’s a company that specializes in lending against it. It used to be hard to get a loan. With so much competition out there, it’s far easier now.
Put it all together
Let’s combine all our previous points together. Today you have:
- Record low interest rates
- Easy to get credit
- Lots of available money
- Relatively minor penalties for those who abuse debt
It’s pretty much the perfect storm for people who want to borrow money.
All borrowing does is enables consumption today in exchange for paying more for it down the road. The cost of this is less than ever while you could argue the benefits are as great if not greater than they were years ago.
You used to be able to get a nice union job without a college education. Those are few and far between these days. You used to be able to buy a nice place for between two and three years gross income. That doesn’t happen today unless you choose to settle down in a place with a population less than four figures. And so on.
When interest rates go down, the rewards for waiting become less and less enticing. It’s almost impossible to get more than 2% annually on your money without taking risk. This isn’t a world that rewards savers.
Basically, by borrowing more when rates go down, people are reacting exactly how we should expect them to. We encourage companies to borrow more when rates are low, even to do something as mundane as buying back stock. Why shouldn’t we encourage similarly rational individuals to do the same?
Ultimately, debt is a personal finance sin. But in 2016, the reward for delaying consumption is as small as it’s ever been. Keep that in mind before criticizing your friend who’s financed to the hilt.