Canadian households are more indebted than they think. A new report from Quebec-based Desjardins’ shows households recently accumulated a world class amount of debt. In fact, households borrowed so much that they’re now the third most indebted across the world. Even more surprising is the fact this debt is mostly held by just a small share of households.
Canadian households have been on an epic borrowing spree. At the start of 2020, they interpreted record low rates as a signal to borrow as much as possible, as fast as they could. From Q1 2020 to Q1 2024, household debt climbed a whopping 25% higher. Two-thirds of the accumulation occurred before the first rate increase in Q1 2022.
The debt surge helped put households amongst the most indebted in the world. They now owe over 100% of GDP, making Canadinan households the third most indebted in the world, and the most indebted of any G7 economy. It’s only beat by Australia and Switzerland, with both respective economies just a fraction the size of Canada.
Source: Desjardins.
Unfortunately, all good times come to an end—usually quite dramatically when it comes to debt. Record low rates were so successful in driving new debt the Bank of Canada (BoC) had to follow it with a record sharp increase. Clearly the central bank didn’t plan on the borrowing spree, which abruptly halted its promise of rates being “low for long.”
The recent rate cut provided some relief for borrowers caught in the hikes. However, rates won’t be falling to provide relief nearly as fast as they climbed.
“The BoC recently cut its policy interest rate, kicking off what is expected to be a gradual cycle of reductions,” explains Maude Drapeau, Economist at Desjardins.
She adds, “But at 4.75%, the key rate is still high from a historical perspective. This cut comes after a period of aggressive monetary tightening, both in terms of scope and speed, during which the policy rate shot up from a low of 0.25% in March 2022 to 5.00% in July 2023—all while Canadians found themselves saddled with some of the highest levels of household debt among advanced economies.”
Even if rates were cut, the distribution of relief provided may not provide the expected relief to the economy.
Canada’s wealthiest households did most of the borrowing when rates were cut. Desjardins found the top two-fifths of households by income owed 55% of outstanding debt. It makes a lot of sense, since most household debt is mortgage credit. During the recent low rate boom, investors were responsible for most of the mortgage borrowing. Even the country’s largest bank warned that investors were replacing first-time borrowers in their portfolio.
The same demographic also makes up most of the savings, according to Desjardins. Households in the top 40% of earners saved an average of 23.5% over the past 10 years, with the wealthiest putting more aside as rates climbed. This may indicate yield chasing is responsible for a signficant share of residential investment, where investors are using rents as a substitute for bonds when rates fall.
Source: Desjardins.
Canada’s bottom 60% of households owe the remaining 45% of outstanding credit. Drapeau notes this demographic also saw negative savings—spending more than they make. She attributes this to the rising cost of living, consuming a disproportionate amount of their income.
Canada has been warned for years about its reliance on mortgage credit to drive its economy. It started before 2020 rate cuts, as global agencies warned it would amplify vulnerability in a crisis. When the whole world got record low rates in 2020 to fuel new borrowing, Canadians poured that fuel onto an already out-of-control fire.
Now the country is in a lose-lose situation. Higher rates are penalizing end users, but also curbing excess speculation. If rates remain too high, the small share of end users experiencing stress from higher rates will be collateral damage. If rates are cut too rapidly, those households will find some relief, but young adults may not as investors see the return of cheap capital.
