Why cash-strapped Canadians could soon be pushed to bankruptcy

“Wickedly high.”

That’s how Doug Hoyes describes the amount of debt Canadians are carrying. And he would know: the licensed insolvency trustee spends his days working with people who are drowning in debt, at a time when consumer insolvencies are hitting the highest levels since the start of the pandemic.

Interest rates are rising, a recession is looming, and inflation is pushing up the price of everyday goods such as groceries, which are now so costly that some are skipping meals.

There’s a debt crisis brewing, economists say, and it’s pushing cash-strapped Canadians, now carrying an individual average debt load of $21,128, to the brink.

Already, for every dollar of income earned, Canadians owe $1.81 in debt.

“It’s just going to keep getting worse,” Hoyes said, as more Canadians turn to credit to pay for necessities.

Between new lending as demand for credit rises and higher spending linked to inflation, consumer debt in this country — excluding mortgages — has climbed to $591.4 billion. That’s an increase of more than five per cent compared to the same time last year, according to a recent report from Equifax, a credit reporting agency that tracks credit scores and debt.

Total consumer debt grew by more than eight per cent in the second quarter of 2022 — to $2.32 trillion — compared to the same period a year ago, the Equifax report shows. Overall, the amount Canadians owe on their credit cards is at the highest level since the fourth quarter of 2019.

The numbers are so alarming that Canada’s big banks are preparing for a worst-case scenario, setting aside millions of dollars in anticipation of a wave of loan defaults.

The Equifax report found consumer insolvency — people who can’t repay their debt — has risen to the highest level since COVID-19. Consumer proposals, a method of debt management wherein an insolvency trustee puts forward a lower payment plan to creditors, are up 20.7 per cent compared to a year ago, and account for 76 per cent of all insolvencies.

These rising debt levels represent a marked shift from the pandemic era, when non-mortgage debt such as car loans and lines of credit fell by a record $20.6 billion, according to Statistics Canada, in part due to government support programs and a slowdown in non-essential spending.

Hoyes, who is co-founder of debt counselling firm Hoyes Michalos, anticipates a worsening situation as people watch their mortgages become more expensive or see the cost of living continue to rise.

“Everyone can sort of bob and weave for a few months,” Hoyes said. “But with each passing month, more and more people get to the breaking point.”

The inflation factor

Inflation has cooled slightly, but that doesn’t mean the price of goods is dropping. Canadians are stretched thin at the cash register, and more are turning to food banks in addition to credit.

The inflation rate in August was recorded at seven per cent, according to Statistics Canada, down from 7.6 per cent in July, a slowdown largely driven by falling gas prices.

Wages, though rising overall, have not spiked at the same speed as inflation, meaning money doesn’t go as far as it used to when it comes to covering the cost of essentials.

Despite the lower inflation rate recorded in August, the price of groceries has stayed exceptionally high, with food inflation clocking in at 10.8 per cent in August. This, Statistics Canada said, represents the fastest price rise since August 1981. It means, essentially, the same food you bought a year ago now costs on average nearly 11 per cent more.

The high cost of living means Canadians have largely reversed course on the progress they made during the pandemic in tackling debt they owed, and are now seeking credit to fight inflation.

There has been a higher than usual demand for new credit cards, said Rebecca Oakes, vice-president of advanced analytics at Equifax Canada. And it’s people with lower credit scores whose card balances are seeing the biggest increase, according to the Equifax data, indicating they’re likely charging small, everyday purchases to their credit cards to navigate the high cost of living, Oakes said.

The demand is driving competition: lenders are offering higher limits on new cards: the average credit limit is up $1,200 compared to the same period last year. Overall, the average card limit on new cards is more than $5,800, the highest it has been in the last seven years.

The interest rate pinch

Canada’s debt problem doesn’t lie solely with credit cards.

Many homeowners have taken on large mortgages, with some now facing ballooning monthly payments because of ongoing rate hikes.

In a bid to cool inflation, the Bank of Canada has increased interest rates five times since March. The key lending rate now sits at 3.25 per cent, up from 0.25 per cent from the start of the year.

Julia Wendling, an economist with Rosenberg Research, said the higher rates mean homeowners will need to redirect more cash toward their mortgage, leading to a drop in consumer spending.

Wendling said her organization is calling for a pause on hikes following the next Bank of Canada meeting in October. The housing market “has already started crumbling,” she said. “We think that’s going to continue, and that’s it’s going to ultimately lead the Bank of Canada to realize that the Canadian economy, as indebted as it is, cannot support these higher interest rates.”

Other economists share Wendling’s concern.

“We’re facing one of the steepest rises in interest rates in a single year that we’ve seen since the mid-1990s,” said Douglas Porter, chief economist and managing director at BMO Financial Group. Further upticks could mean Canada is facing rate hikes not seen since the early ’80s, he said.

The pandemic boom in the housing market before the rate hikes took hold has led to a new rise in debt levels, largely due to the size of Canadian mortgages, Porter said. That comes with both good and bad news: while the debt is healthier when it is held in mortgages because there is an asset attached to it, is still at an all-time high as a share of income.

David Macdonald, senior economist with the Canadian Centre for Policy Alternatives, told the Star the danger of the hikes lies in their longevity.

If the Bank of Canada continues to raise rates, more of the population will be exposed to the additional stress on their mortgages as more people renew their terms. (Right now, those most exposed are homeowners carrying variable rate mortgages, and those who are currently in the process of renewing).

While it isn’t likely that a large number of homeowners will lose their homes from the added stress, “it’s more that there will be a rash of people becoming house poor,” Macdonald said. “A lot more of their money is going to interest payments on their mortgages.”

The recession question

It remains unknown how hard the first economic downturn since 2007 will hit the country — but between the high cost of living and the rise of interest rates, the situation looks dire.

Wendling, of Rosenberg Research, said a recession is “all but guaranteed” given the Bank of Canada’s rate hikes. With less money available to spend overall, people prioritize essential costs first, which in turn pulls consumer spending out of the economy and leads to a decline in Canada’s GDP, she said.

“We think that the contraction in GDP that we are going to see is going to be a lot more negative than most people realize,” she said. A contraction in GDP shows that economic activity has decreased; if this happens for two or more quarters, it indicates that, technically, a country has entered a recession.

The earliest that could happen here is at the end of the year — if GDP growth is negative for both the third and fourth quarters of 2022.

While some have suggested a recession could turn out to be mild, BMO’s Porter said it’s too soon to know how one would play out. “You can’t know that a downturn won’t turn into something deeper,” he said. “Our household debt situation does make us vulnerable to other shocks that could lead to job losses or further interest rate hikes.”

For its part, the Bank of Canada has consistently argued that Canada’s high inflation justifies the continued rate hikes, even as some economists say they will lead to a recession.

“The governing council remains resolute in its commitment to price stability and will continue to take action as required to achieve the two per cent inflation target,” the bank said at the announcement of its September increase.

By raising interest rates, the cost of borrowing should be so expensive that consumers balk at the price, in turn spending less and driving down the cost of goods, lowering inflation.

But with a recession now on its way, the unemployment rate could rise as businesses look to save money. In the face of job loss, said Hoyes, people simply can’t pay down debt.

In a nutshell, said Hoyes, “we’ve got a big problem on the horizon.”

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