Sarah Colucci's Mortgage Blog
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According to a recent survey conducted by Manulife Bank of Canada, over 92% of respondents believe they have too much household debt, and their debt is drastically outpacing their annual income.
Why is debt becoming a major problem in 2019 and onward?
Most people have debt, and to a great extent, having some debt fuels the economy and creates the backbone of our current banking system.
However, if we looked at a scale that reflected what would be considered low debt all the way to out of control debt in relation to annual income, it becomes evident that edging too far in the heavy debt zone creates tremendous risk of the inability for borrowers to repay loans and ultimately brings about devastating financial consequences.
The reason for massive debt could be twofold. On one hand, incomes are simply not in line with inflation and on the other, the banking sector offers many different forms of financing and credit to consumers who may not appreciate what could happen to their ability to repay debt in a rising interest-rate environment. This is especially true when it comes to mortgage loans. A survey conducted by Ipsos for insolvency firm MNP Ltd. and published by Bloomberg, articulated very clearly that many Canadians were just $250 away from insolvency.
There are two types of debt that borrowers can have.
The first type of debt is called Unsecured Debt, which means it's not tied to any chattel or asset like a car or a house, and a lender cannot launch procedures to take possession of the asset to recover damages. For example, a power of sale proceeding or repossession of a vehicle would allow a lender to obtain the asset and re-sell it in order to recover the funds lent to a borrower who could not repay their loan.
The second type of debt is called Secured Debt, meaning it is registered against property as collateral or via the Personal Property Securities Act which gives the lender a right to ownership of the vehicle or property in ways described above.
Unsecured debt carries more repayment risk for financial institutions as well as borrowers in two very different but interchangeable ways.
First off, because a lender has limited recourse which won't allow it to be able to recover the money lent (i.e. it cannot launch a power of sale or seize the vehicle if the loan doesn't have any collateral attached to it), it risks having to write the debt off off as "bad debt" if it cannot be repaid by a borrower. Millions of cases of 'bad debt" loan write offs wreak havoc on any financial system (think 2008).
According to the Office of the Superintendent of Bankruptcy Canada, insolvencies (bankruptcies and consumer proposals) increased by 11.3% in January of 2019 compared to the previous month. Bankruptcies increased by 4.2% and proposals increased by 16.9%.
Clearly, there is an increase in the number of people who cannot repay their loans which is happening in conjunction with rising debt levels year after year which are currently sitting at 171% per capita. This means for every $1.00 a Canadian earns, he/she owes $171 in debt to creditors.
The other equally paramount issue borrowers face with their unsecured debt is it's easily accessible and doesn't require much paperwork to put in place like a mortgage does, for example, which makes borrowing more tempting. It also carries steeper interest charges and other related costs.
The Biggest and Most Dangerous Debt Trap
Credit cards often become a trap - we don't have to postulate on this statement.
Credit card balances are currently charged at four to five times the interest rate of secured loans, and the interest is compounded daily. This means that if a credit card is maxed out, not only can monthly repayment be challenging because of the highly inflated interest rate, the loan can actually become impossible to pay off because interest is accumulating and compounding itself every 24 hours. And so borrowers continually find themselves in situations where they can only afford to make minimum monthly payments and, therefore, never get out of debt. Add rising mortgage interest rates to the equation, and the perfect storm ensues.
In case the picture is not clear just yet, making minimum payments year after year becomes a huge drain on a family's finances because they quite simply can never get ahead. Credit card debt is like an illness that never gets better and each year; it makes a person sicker and more and more incapable of 'living.'
But credit card loans are not the only "disease" that has negatively impacted society. Car loans are now being amortized as long as eight years and creating more financial problems for borrowers. Although approving longer amortization on vehicles makes the monthly payment appear more affordable, the reality is longer amortizations mean more interest is being paid, which ultimately makes the cost more expensive.
In contrast, home loans are amortized over a much longer period (i.e. 30 years); however, real estate is generally not considered a depreciating asset, whereas car loans can depreciate up to 20% on the date of purchase and just from driving them off the lot. Vehicles have a shelf-life so a borrower could be paying huge costs on an item that will be of no use in less than a decade.
How to Protect Yourself
It can be difficult to get out debt once you have come to a place that seems to be beyond repair. However, in order to have peace of mind and financial well-being, your debt must be drastically reduced and managed if it is otherwise deemed unsustainable.
Debt not only causes financial problems, but it also causes issues relating to a person's mental and physical health.
If you are a homeowner, your property can help you manage your debt, which will assist you in becoming debt-free. Using your property can also help you manage your monthly cash-flow more wisely, putting YOUR money back into YOUR pocket.
If you are not a property owner, consider speaking to a trustee about reducing your debt, recovering your monthly cash flow and ultimately, "cleaning your slate." Everyone deserves a fresh start with peace of mind.
By: Sarah Colucci
Senior Mortgage Agent, Lic. M14000929