Debt-Payments-to-Income. A Trend to Watch

Debt-to-Income

The statistic making headlines this week is the latest debt-to-disposable-income ratio. It just hit a record 150.8%. Not all of that is “bad” debt, and much is offset by assets, but it’s still a head turning number.

Despite the widespread use of this statistic, however, CIBC economist Ben Tal says folks should focus less on that figure and more on debt payments vs. income (aka., the TDS ratio). That’s a better indicator of people’s ability to stay solvent.

When asked what a reasonable debt-payments-to-income number is, he told the Vancouver Sun:

Benjamin-Tal“We say that if more than 40% of your income goes toward servicing debt, that’s too much…I would go for 30; 30 is fine. But 30 today, does not mean 30 tomorrow, and that’s what people miss.”

That, of course, is because interest rates can and will increase. When that happens, people’s debt payments go up but their income doesn’t necessarily follow.

“Many of us are becoming blinded by low interest rates,” he said.

“If [the interest rate] is now 2%, and 40% of your income is going to servicing debts today, then you’re in a problem when the rates go up.”

Fortunately, Mr. Tal’s research finds that only 6.5% of mortgagors currently have a TDS ratio over 40%, reports the Vancouver Sun. (By comparison, in 2008 CIBC said ~5% of households had a TDS more than 40%.)

The more “fragile” segment of the market consists of those borrowers with a 40%+ TDS and less than 20% home equity. Less than 1 in 20 borrowers meet that definition, or roughly 300,000 mortgage holders by our estimation.

The concern with these numbers is that debt payments are climbing compared to income. Moreover, when the Bank of Canada resumes its rate hike campaign this negative trend will almost certainly accelerate.

For these reasons, we wouldn’t be shocked to see it get steadily harder for high-ratio borrowers with above-average debt to qualify for mortgages. Lenders and insurers may increasingly scrutinize applications with smaller down payments and TDS values above 42%. In some cases, they already are.


Rob McLister, CMT

  1. Hi Ray,
    The latter stat (150.8%) is more commonly quoted. It’s the one that makes most headlines because it focuses on mortgage and consumer debt. It’s also the one typically used to compare Canada to other countries, like the U.S. As you correctly suggest, the technical name for it is “Credit market debt to personal disposable income.”
    The former figure (152.98%) rolls in other liabilities, such as small business debt. It’s not as relevant from a mortgage lending perspective since some of its components are not used in TDS calculations. Hence, we don’t use it.
    Cheers…

  2. This is a good article I wrote about this same subject yesterday. The real kicker is when you look at stats can website and look at the median household income vs average consumer debt on loans and credit cards over 25% of Canadian household debt is tied up in high interest financing. For some reason it seems Canadian’s are not learning from our U.S. counter part and learning to differentiate between needs and wants and certainly not establishing solid budgets.
    http://www.aaamortgages.wordpress.com

  3. Great post! I’m concerned about Ben’s stat suggesting only 6.5% of mortgagors have a TDS over 40%. As an industry member, I would suggest that stat is much higher.
    Payment shock will be an unfortunate reality for some in the coming years. With the new refi rules, consumers can no longer use their home as an ATM. Just a matter of time!

  4. If I’m reading this right, Canada 5 Year Bond yields have hit new record lows on Thursday, Tuesday and yesterday. Yet not a murmur about banks dropping five year rates.
    Is this all just Euroshock with declines too small to matter to banks padding their amrgins or is something else going on

  5. Great post as always Rob. I do see this too much as I do a lot of refi’s and seconds. I think these 2 products are a wonderful tool for specific issues such as unexpected illness or a job loss. . .even to pay for a university education. (Not everyone has thousands that are liquid; that can be pulled out for emergencies)
    But time after time, it’s just to pay off credit debt, leases etc. What a shame.

  6. After 20 plus years in banking, mortgages, CFP. AMP, etc., there lies, damded lies, and statistics. We can slice this six ways to Sunday and conclusion is the same. Too many idiots at banks who cannot calculate a TDSR and are afraid to say no to clients when they obviously do not qualify for more. I always advised people to live modestly if they want to save money for a home but no…gotta keep up and in debt with the Joneses…

  7. What’s overlooked with this statistic is the drivers behind the ratio increase in Credit Market Debt to personal disposable income. For example, the taxation burden has eaten away at disposable income making it more difficult for families to get ahead, thereby increasing the percentage. Certainly, the loss of high paying, manufacturing jobs and their subsequent replacement with lower paying service jobs and/or primary industry job has impacted disposable income, thereby increasing the percentage. While the use of credit – increasing the percentage – has been increasing recently, it would be more telling if we looked at each of the variables’ impact on this trailing indicator.
    What are the leading indicators showing? Has income kept pace with inflation over the past 50 years? How much more money is being funneled from family budgets to the different levels of government? How does the amount of credit available and in use compare historically? Which of these variables has had the greatest impact on this percentage?
    No doubt the number is scary and likely to get bigger, but if we don’t fix the cause, we aren’t likely to bring that number down any time soon. Saying we’re higher than the US and Europe is meaningless; both of those economies are in a tailspin because consumers are not spending. I wonder if the credit usage restrictions – individual choice or tighter lending criteria – are contributing to their malaise?
    What was the line about statistics, especially trailing indicators?

  8. It is laughable that the banks will be tightening the rules and scrutinizing harder when they are the ones pushing the unsecured debt. We now see more of them going to a collateral mortgage model where they have tied up the entire property….essentially financing well above the 85% ceiling, if we consider the unsecured debt from that same lender.
    I have Clients tell me stories of credit being “foisted” on them without having requested it. Banks hand it out based on their performance models and then say they worry about people borrowing too much.

  9. Great post Rob.There are unfortunately too many Canadians who have hit a wall-or soon will when interest rates eventually rise-with after tax incomes not keeping up with cost of living and are using unsecured debt to maintain an unrealitic and unsustainable lifestyle.
    There is a very good financial fitness quiz at http://bit.ly/uisar1 that anyone can complete to help them focus on what changes they need to consider so they can reduce their debt and achieve their financial goals.

  10. Just because banks give some borrowers more rope doesn’t mean they’ll let everyone hang themselves.
    This is Canada. You still have to qualify for the privilege of taking the bank’s money.

  11. Much of the cause is peoples’ need for instant gratification. Everyone has to buy everything now. How do we “fix” that?
    I think it’s reasonable to compare Canada’s debt ratio to other stable economies with similar credit standards. We have to benchmark ourselves somehow. Although I’d agree that comparing ourselves to the US is pointless. Half of the debt run-up there was caused by irresponsible lending which is not the case here.

  12. Here’s more detail from StatsCan on the difference between the above two statistics. Our thanks to Mark Joshua there for this definition.
    “The only difference between ‘Debt’ and ‘Credit market debt’ is that Debt includes trade payables on the part of unincorporated businesses.”
    “A trade payable in this case covers the short-term credit received in the ordinary course of business by unincorporated businesses. The credits are outstanding from the time the goods or services are received until payment is provided. Trade credit does not constitute a marketable instrument like short-term paper, nor is it negotiated like a bank loan.”

  13. Crazy how many years it took to get to this thinking. I always find it interesting what amount of debt people are allowed to obtain. I know we are brokers and obviously perform business for quite a few clients in this situation…but currently I have many with bad debts etc….where I start to question why and how they got this. I would love to see more transfer switches with equity paid down and no debts to payout. :) We will be there soon with all ‘us’ brokers doing our best to educate our clients!

  14. this blog falls on deaf ears to the “keep up with the joneses” types. in other words we can blab to each other all we want about record debt levels but the joneses are none the wiser.

  15. It seems clear enough that there is a bubble in the price-to-income ratio, and the related debt-payments-to-income statistic. Also, there should be worries about the ability of some heavily indebted Canadian borrowers to continue making their payments if rates rise. Good article.

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