Drowning in debt is the new normal in Canada

An expert in consumer insolvency describes what it’s like on the front lines of Canada’s worsening household debt crisis


 
The Canadian Press/Ryan Remiorz

The Canadian Press/Ryan Remiorz

On any given day now you can expect to hear at least one economist, public official or financial commentator express grave concern about the mountain of debt Canadians now carry. The bloated debt loads of Canadian households has become a pervasive topic in media. But for all the attention the subject has received, it’s a safe bet that most people still cling to very clichéd notions that only so-called “deadbeats” ever hit the debt wall. Nothing could be further from the truth. The reality is Canadians would be shocked if they could peer into the private financial lives of many of their closest neighbours and friends.

As a licensed insolvency trustee firm, our practice is on the front lines of Canada’s household debt binge and the bad personal finance habits that ensnare so many people. And what we see every day is that the majority of those grappling with serious debt trouble are the most typical individuals and families you could imagine.

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Here is just a sample of recent files that have crossed our desks: A staff accountant with multiple lines of credit, several maxed-out credit cards, a big mortgage, a significant home-equity line of credit (HELOC) and two leased luxury cars; a TTC driver with two mortgages and $100,000 in unsecured lines of credit; a teacher with eight payday loans and a senior financial analyst at a chartered bank with seven credit cards, all carrying high balances. I could go on and on.

Those disturbing financial cases are no longer the extreme end of the spectrum that they were at one time. They are the “new normal” in our trustee practice. The real horror stories are far worse, albeit less frequent.

READ MORE: How Canada completely lost its mind over real estate

The normalization of excessive debt is reflected in the data that Statistics Canada regularly releases. The household debt-to-income ratio now stands at 169.4, up 23 per cent from a decade ago, and on par with what the U.S. saw at the peak of its housing bubble. Of course, such figures are averages. According to the Bank of Canada, close to half of all high-ratio mortgages originated in Toronto were to borrowers with loan-to-income ratios in excess of 450 per cent.

A growing number of the clients we see have all the trappings of a middle class lifestyle—they’re gainfully employed, own a home and from the outside seem fiscally responsible—but it’s built on a foundation of debt and bad financial decisions. Many cases involve large tax arrears, such as a real estate broker who owes $383,000 to the Canada Revenue Agency in unpaid income tax. Others involve failed businesses. Then there are the frequent cases where financial companies inexplicably lend vast sums to underemployed people, even as their debt loads balloon out of control—in one case, a senior who emigrated to Canada 15 years ago, had never worked and been on a very low disability pension since shortly after arriving, owed more than $200,000 in credit card debt.

While the causes for these horror stories are varied and obviously complicated, there is almost always a common detail: Most clients in significant debt trouble today would not be in that situations had they simply funded their lives by cashflow instead of credit.

And that may be the crux: a decade of low interest rates has fuelled habitual credit reliance by consumers. Two or three decades ago, it would have been unthinkable for people to hold the equivalent of $30,000 or $40,000 (or more) in credit card debt. Yet now that has crept into the Canadian psyche as just something one does.

(By the way, have you noticed the “Estimated Time To Pay” wording on your credit card statement? It is a calculation of how long it will take to pay off your credit card balance if only the monthly minimum payments are made. The record we’ve seen is 330 years and 10 months. Don’t forget, a credit card balance of as ‘little’ as $6,000 can take more than 40 years to pay off if only the minimum payments are made.)

A lot of credit card debt, of course, has in the last few years been shifted over to lower-interest lines of credit, usually unsecured. This Peter/Paul conundrum is interesting: we very often see examples where people have paid off their credit cards using available lines of credit, only to have their credit card balances swell back to where they were within a year or so.

READ MORE: Canadians can’t stop lying to themselves about debt

Let me share a scenario of someone who is self employed, as it highlights how a debt problem can spiral out of control quickly. I met recently with a woman in her 50s who owns her own company that furnishes and decorates high-end businesses, like big law firms. Or at least it did. With big firms shrinking to meet reduced market demands and trimming costs, her business had dried up.

Her accountant brought her to me, and it was clear she had severely mismanaged her business and financial affairs, despite her accountant’s warnings. We see this all the time—small business owners are typically very good at what they do, but very poor at handling day-to-day administration.

Here are some specifics that show how misaligned her lifestyle and business expenses were with the actual cash she was earning:

• Owns a townhouse: mortgage $600,000, estimated value $650,000

• Mortgage payments: $3,600/mo

• CRA lien against house for personal income tax owing: $98,000

• She had previously refinanced her house to help fund her business

• She had a prior bankruptcy 15 yrs ago—discharged

• Leased car: $51,000 owing

• Credit card debt: $75,000

• Business loan (personally guaranteed with a high interest rate): $45,000

• Outstanding debts to suppliers: $80,000

• Business rent owing (seven months behind): $11,000

• Net self-employment income: $3,500 per month, or $42,000 per year

The CRA lien is the big problem here. She can’t sell or refinance her house with the existing lien unless she pays her back taxes, while in the meantime interest charges and penalties pile up.

Although this may seem hopeless, it is actually a straightforward personal bankruptcy scenario: She closes the business, any source deduction or HST owing is included in the personal bankruptcy filing, as are any personally guaranteed business debts. She walks away from her house and cannot be sued for any shortfall due to the creditor protection afforded by her bankruptcy. She will lose her house and business, but that almost certainly would have happened regardless.

I should point out that clients in this type of situation often insist on keeping their house, a reflection of the deep-seated Canadian devotion to home ownership, and it takes long and difficult conversations with family, friends and trusted advisors before they come around to the realization that they have to let go of their home.

Keep in mind that the above situation is very normal for us. This is something we see every week.

As stated earlier, the most troubling trend we see now is the flood of regular Canadians facing financial crisis. Households and individuals who are employed, have decent incomes, own homes and have done everything they feel they ‘should’ be doing now find themselves facing serious, if not insurmountable, debt problems. They are having to file insolvencies now, or will in the next few years.

READ MORE: The Bank of Canada’s muddled message on house prices

There are possible alternatives to outright bankruptcy, of course. Often, if clients have serious debt problems but also decent incomes, they will attempt a consumer proposal to settle their debt legally through a licensed trustee. In effect, creditors agree to accept just a portion of what they’re owed (which is more than they might get if someone is forced into a personal bankruptcy situation). This allows people to keep their assets (house, vehicles, investments, cottage, etc.) while eliminating unsecured debt they would otherwise have little chance to pay off in the normal course of life. The credit impact in a proposal is easier than a bankruptcy, and one can rebuild credit in a few short years. It’s a growing option for debtors. In fact, about 50,000 Canadians file proposals every year, and that number is rising.

Increasingly, life has simply become too unaffordable for many. The temptation to spend is too great, and access to cheap debt too easy. When the gap between what people need or want, and what they can afford with their incomes becomes too great, credit is used to fill the gap. Interest kicks in, and the cycle begins. As credit card debt is shifted to readily available lines of credit, $5,000 becomes $15,000, and soon you’re facing a $50,000 or $100,000 debt problem. A person living at or below the median income range simply cannot handle this.

Unfortunately, that’s a lot more ‘normal’ than you think.

 

Scott Terrio is an estate administrator at Cooper & Co. Ltd, a licensed insolvency trustee in Toronto. Follow him on Twitter at @CooperTrustee

 


 

Drowning in debt is the new normal in Canada

  1. In our society everybody feels it is their right for instant gratification. Life is too short to save. Our society is in for a rude awakening. Saving to pay for stuff is way more satisfying but not quite as instantaneous.

  2. The only actual metric in this story is ‘debt-to-income ratio’ yet the more common metric applied to enterprise is debt to equity ratio; apparently, economics for individuals is different than for enterprise … or not. The article of course attempts to hype the argument by omitting to say said ‘ratio’ is actually a percentage. The actual cost of debt is the cost of servicing debt. Obviously, some debt such as credit card debt and unsecured credit is toxic due to high carrying costs that regulators keep just shy of blatant usury: the problem is only partially that of the unwary consumer (sheep aren’t entirely to blame for being bitten by a wolf). Having experienced a brief stint of 21% interest on a mortgage with a debt-to-income ratio of 0.5, I can recall that the cost of servicing debt is at least as important as the size of the debt: in this case, servicing mortgage debt at 21%x0.5=11.5% of income which is 4 times 2.6%x1.68=4.4%. The issues, are as follows: 1) financial institutions are allowed predatory terms and predatory tactics, 2) financial institutions are more concerned with volume than quality of loans, 3) to some extent regulations that make it harder to buy real estate and have higher initial equity encourage this behavior by financial institutions, 4) interest rates could go up but would never hit historic high levels, consequently the resilience to cost of borrowing is only slightly threatened, 5) housing is the majority of personal debt (let’s not conflate small business and ordinary personal debt like the author) where bad planning and regulatory constraint have created a lack of supply causing housing prices to escalate – no amount of histrionics from the author will make a family of 3 with another on the way less desperate to find suitable accommodation. Contrary to what Kathleen Wynne would have us believe, no amount of bachelor condos and 1 bedroom rent controlled apartments will make housing more affordable nor reduce the critical need for suitable housing. The author also makes out that participating in the market is optional since living on the street is an available choice.

  3. In my experience many people just put their heads in the sand when it comes to managing their own finances. They just carry on getting more and more credit from the banks and hoping things will work out. When I point out that it will never work out….they complain that the banks should have told them long ago and reigned them in. They feel someone should be looking out for them and the “system” let them down. So maybe it all comes down to bad parenting. Nobody taught them how to manage money. Nobody taught them how to be responsible for themselves. It is so hard for them to accept responsibility for their failure. So they go bankrupt or whatever and become disgruntled citizens looking for ways to cheat the system that let them down. Many drain their parent’s good will and finances with no remorse. On the other hand, I have met many friends who pride themselves on being self reliant and living within their means. Cooking their own meals, growing fresh tomatoes, shopping at consignment stores and planning for well deserved treats like going to McDonald’s for coffee once a week. They feel so good having control over their own destinies.

    • “…well deserved treats like going to McDonald’s for coffee once a week.”

      Now THAT’S funny.

  4. Most people don’t know how to handle money…..it doesn’t come naturally.