The Look of Household Debt in Canada

The Bank of Canada calls it "home-equity extraction,î denoting the ability of homeowners to borrow against the steadily increasing value of their homes. These secured personal lines of credit (PLC) ó secured by the borrowers' homes ó have become a significant factor in the run-up of household debt since the late 1990s.

"Secured PLCs, which are mostly secured by housing assets, have risen sharply both in absolute terms and as a share of total consumer credit,î say researchers Allan Crawford and Umar Faruqui, authors of "What Explains Trends in Household Debt in Canada?î in the Winter 2011-2012 edition of Bank of Canada Review.  "In 1995, secured PLCs represented about 11% of consumer credit; by the end of 2011, this share was close to 50%.î

We are all aware that the ratio of household debt to disposable income has climbed in Canada, particularly over the past decade, with debt reaching 150% of income. This has distressed central bankers, politicians and market monitors, as they consider the impact of domestic household finances on Canada's economic and financial well-being. (See Knowledge Bureau Report, Jan. 25.) As a result, the latest Review turns its attention to issues and trends around household debt in a special issue entitled Household Finances and Financial Stability.

As editor Graydon Paulin notes: "The articles in this special issue of the Review reflect two important facts. First, in recent decades, there has been a steady increase in Canadian household indebtedness. Second, real house prices in Canada have exhibited an upward trend since 2000. These facts are interrelated, since rising house prices can facilitate the accumulation of debt. Households could, therefore, experience a significant shock if house prices were to reverse.î

Crawford and Faruqui argue both mortgage and consumer credit have contributed to this higher ratio. Gains in real income coupled with low interest rates have made home ownership more affordable, and the home ownership rate has risen accordingly. As well, since the late 1990s, house prices have risen at a faster pace than income. This all adds up to ratio of mortgage debt to disposable income that has climbed to 100% over the past 30 years from 50%.

"Before the mid-1990s, the increase in the debt-to-income ratio was driven mostly by residential mortgage credit,î report Crawford and Faruqui. "But since then, consumer credit has also been a contributing factor. The rising importance of consumer credit has coincided with a strong increase in non-mortgage borrowing secured by housing assets.î

Financial innovation, supported by an exuberant housing market, has given homeowners access to more non-consumer credit in the form of PLC and home-equity extraction. That takes the ratio of consumer debt to disposal income over the 50% mark.

So, household debt has accumulated and all eyes are on the housing markets. A market crash could put paid to Canada's modest recovery. The end result: Canadians should tread cautiously. Keeping our economy onside requires a careful balancing act.