Monday, March 20, 2017

Stressing over the debt-to-income ratio? Don’t!

The debt-to-income ratio has hit the headlines again.  This time the ratio rose to 167.3 % in the fourth quarter of 2016 compared to 166.8% in the third quarter. That means for every dollar of disposable income, consumers owe $1.67.

This increase has been fuelled by mortgages and low-interest rates, which has some policy-makers getting antsy.  They’re concerned at what could happen if rates rise. Yet consumers have been able to pay their debt relatively easily. And low interest rates have allowed consumers to pay down more of their mortgage principal, with payments split almost evenly between interest and principal in the fourth quarter.

Benjamin Tal, Deputy Chief Economist for CIBC, isn’t having it and is calling an end to the debt-to-income ratio. In his weekly Market Insight he calls the ratio the most quoted number and the most useless economic indicator. The main reason is what the number is assessing versus what it doesn’t assess.

For example, it’s unlikely that consumers will pay off their mortgage in a year, yet the total debt amount is factored into the debt-to-income ratio.  Mortgage debt accounts for 65.5% of ratio.  The ratio also looks only at the debt of consumers who already have debt rather than the income of people with and without debt.  Perhaps not a totally accurate picture, then.

According to Tal, in a “normally functioning economy, debt will rise faster than income.”  The ratio is designed to rise and has only fallen twice in the past 25 years. 

Tal also pokes holes at the pace of increasing debt. Here are the numbers:

  • Total real household debt is now rising by just over 4%, in line with the recovery of the 1990s
  • Consumer credit is  rising by only 2.5%, slowest pace over the past 30 years (non-recessionary)
  • Mortgage credit rising by 5.2%, which is low
  • Household incomes rising at 2.5%, the long-term average
  • Seems pretty normal.

TD Bank economist Diana Petramala wrote “Debt growth has accelerated somewhat, but it is not growing at the double-digit pace that would typically be considered dangerous.”

Equifax has reported that 46% of consumers were decreasing their debt.

So, Tal is pretty clear when talking about debt -- make sure to say something about what’s included in that debt. The simple catch-all number may be too simple for a complex story.

If you are carrying high interest debt and want to talk about opportunities to consolidate by refinancing, speak with a mortgage broker.

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