There are some personal finance topics that require a good dose of nuance. The thorny subject of credit is one of them. You probably already know that personal enrichment occurs, in theory, through savings and not through debt. It would be playing ostrich not to consider the considerable increase in credit card borrowing in Canada. If the phenomenon has lasted for decades, it has been more intense since 2021. The use of credit has been so systematized that it seems that no one questions it anymore today.
In the second quarter of 2024, the ratio of household debt to disposable income was 175%. This means that, for every $100 of income, these households owe $175, including all forms of debt: loans of all kinds — including mortgage loans — and current consumer credits. Alarming situation or not?
Credit card or line of credit, the main culprit?
Since purchasing a property using a mortgage loan is generally considered “good debt”, or forced savings, many will qualify this ratio, deeming it more or less worrying since it is partly explained by the rise in property prices. While there is no doubt that indebtedness through a mortgage loan is in theory more advantageous than accumulating consumer debt, we need to take the thinking further and look at the indirect impacts of the rise in house prices.
First, savers tend to buy a house according to their maximum borrowing capacity, whereas they should do so by sticking to a carefully considered pre-purchase budget. Otherwise, immediately forget the notion of investment and accept the fact that you are paying for comfort. Indeed, even if the house is an important asset of the budget which will potentially increase in value over time, the pernicious effects of buying a house outside the budget will be observed in the long term: reduction or cessation of the investment for retirement and even, potentially, the start of credit card debt for discretionary consumption. Mortgage payments are always paid as a priority, but the cash available in the budget for the rest is then reduced.
The other phenomenon which this famous rate of 175% does not take into account is the practice which has become more systematized which consists of using the line of credit to finance personal consumption while carrying out a form of consolidation during each renewal of the mortgage loan. loans with higher rates (credit cards, car loans, personal loans for furniture purchases, etc.). The increase in this debt-to-income ratio is therefore not explained solely by the real estate market.
Is it possible to live without credit?
Don’t get me wrong, I am not saying here that it is advisable to live without having to resort to credit and to pay everything in cash, on the contrary. Often, financing certain major purchases, such as cars or renovations, for example, allows you to conserve cash for other financial strategies, including stock market investing, real estate or starting a business. Business owners know: to get rich, you have to use the levers at your disposal and manage your cash flow well.
Credit also makes it possible to use strategies such as setting aside money, for self-employed workers and owners of personally owned rental properties. The practice consists of transforming loan interest that is not deductible from income into deductible interest. The credit then makes it possible to use RRSP loans on an ad hoc basis, making it possible to avoid higher tax payments than expected or to catch up on preparation for retirement.
Thus, overall liquidity management for many households requires not demonizing access to credit. On the other hand, financing luxury or comfort constitutes a real danger for the health of the financial balance sheet in a consumer society like the one in which we operate.
What would define reasonable debt?
It is impossible here to define a universal debt rate to target, since no precise percentage can be adapted to all stages of life. At the start of working life, it is quite possible that because of student loans and the purchase of a first property, the debt rate is generally higher.
A good example of reasonable debt would, in my opinion, be to prioritize the use of credit for the acquisition of durable goods as well as for investment purposes. Reasonable debt does not include debts made to consume beyond our actual income. For example, a loan for an automobile or a recreational vehicle is not a problem in itself. It is the choice of the vehicle model that can become one. So the real question is: am I buying a car with a sale price that is too high for my budget because I have access to credit?
In short, the monthly payments associated with the repayment of the debt (including the mortgage loan) should make it possible to complete a budget which also integrates savings and investment as a priority over comfort and luxury. The use of credit cards should only be considered if paying off the balance in full each month is realistic.