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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