Canadians are starting to feel the impact of their debt-driven spending. Statistics Canada data illustrate that the debt service ratio has reached a multi-month high. In Q2 2018, Canadians spent the most servicing debt since 2008. However, mortgage debt was the eye-opening news as Canadian homeowners are spending the most since 1993 to stay afloat.
The debt service ratio (DSR) is the percent of disposable income used for regular loan payments. Disposable income is the money left over, net of taxes and non-discretionary spending. Since paying debt down is basically paying for something you’ve already bought, the higher the DSR, the slower the future growth. Less disposable income means less future spending which is relevant for economic growth.
While reviewing the breakdown of mortgages, there is an observed high that Canadians haven’t seen in decades. The mortgage DSR was 6.51% in Q2 2018, up 3.33% from the year before. Mortgage interest alone had a DSR of 3.55%, an increase of 8.89% over last year. The amount spent on mortgage interest in the quarter reached an astounding $47 billion. A good portion of the increase is likely due to rising interest rates.
The fact that the majority of this debt is mortgage-related is semi-good news. The principal paid on mortgage debt is retained as equity, which helps build wealth. One thing to remember though is that cash is still being removed from consumer spending and productive investments. This, in turn, could be a drag on the economy that gets worse as rates continue to rise. Ironically, a slow economy reduces asset values, diminishing equity built with the principal.
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