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Household Indebtedness and Financial Vulnerability – Recent Developments and Outlook.pdf
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This report reviews recent developments in household finances and assesses prospects for financial vulnerability over the medium term based on PBO’s April 2017 Economic and Fiscal Outlook. The assessment, however, is based on financial indicators that represent economy-wide averages, which can mask wide variation across households.
- Household indebtedness increased sharply over 2002 to 2011 and then appeared to stabilise through the first half of 2015 at just under 170 per cent of disposable income.
- Since mid-2015, household indebtedness has ticked higher, reaching 174 per cent of disposable income in the first quarter of 2017. With household borrowing rates stabilising at historically low levels over this period, mortgage debt and house prices have surged.
What matters more for financial vulnerability is not so much the level of the debt relative to income, but rather the capacity of households to service their debt. Financial vulnerability is typically measured by the debt service ratio (DSR), that is, household debt payments expressed relative to disposable income. In this report, we adopt Statistics Canada’s DSR measure, which includes required principal and interest payments, but excludes debt prepayments. Statistics Canada also publishes an “interest-only” DSR.
- The DSR remained relatively stable around 14.0 per cent from early 2009 through the first half of 2015. Even though household debt increased from 158 per cent of disposable income to 170 per cent over this period, lower borrowing rates offset the impact of this additional debt on total obligated payments.
- Since mid-2015, the DSR has edged slightly higher, reaching 14.2 per cent in the first quarter of 2017. At the same time, the interest-only DSR has continued to trend lower as household borrowing rates have stabilised at historically low levels. This suggests that increased household indebtedness is no longer being offset by lower borrowing rates.
Looking ahead, the extent to which households will become more financially vulnerable will ultimately depend on their debt-servicing capacity, and therefore on the evolution of interest rates and household indebtedness. Despite a projected rise in interest rates, we expect household indebtedness to increase due to continued gains in real house prices and elevated levels of consumer confidence.
- Relative to disposable income, we project household indebtedness to rise from its current level of 174 per cent to reach and then stabilise around 180 per cent of disposable income by the end of 2018.
Household debt-servicing capacity will become stretched even further as interest rates rise to more “normal” levels over the next five years. Based on PBO’s projection, the financial vulnerability of the average Canadian household would rise to levels beyond historical experience.
- By the end of 2021, the DSR is projected to increase by over 2 percentage points, from 14.2 per cent of disposable income in the first quarter of 2017 to 16.3 per cent (Summary Figure 1).
- The projected increase in the DSR to 16.3 per cent would be 3½ percentage points above the long-term historical average of 12.9 per cent (from 1990Q1 to 2017Q1).
- The projected DSR would also be almost 1½ percentage points above its highest level over the past 27 years, 14.9 per cent, which was sustained for only one quarter in 2007.
Compared to our previous assessment in January 2016, we are projecting higher levels for the DSR over the medium term. Despite significant downward revisions to household borrowing rates, upward revisions to the level of household debt relative to disposable income have more than offset the impact on the DSR from lower borrowing rates.