Why we shouldn’t worry about debt-to-income record

One big bank is arguing the debt-to-income ratio is the most “useless economic indicator out there.”

167.3%.

You’ll read a lot about these two numbers in the coming days. That’s the debt to income ratio for all Canadians and it just hit a new high in Q4 of last year.

It’ll be whipped out when arguing against mortgage debt and for policies aimed at safeguarding Canadians from taking on even more debt.

But it isn’t that simple, according to Benjamin Tal, chief economist with CIBC. And the ratio isn’t even that useful.

“The attractiveness of the ratio is that it’s simple —one number catches all. But as we all know, the cost of simplicity is, at times, very high. The ratio compares the stock of debt to the flow of income,” Tal wrote in response to the release of the figure. “You are not required to pay off your mortgage in one year, so on that ground, that approach is faulty.

“It’s also the debt of people with debt, relative to the income of people with and without debt. Again a suboptimal comparison. And if foreign income plays a role in the housing market (and it does) that income is not part of the calculation.”

Still, news organizations jumped on it.

“Canadian households owed $2 trillion at the end of 2016,” the CBC proclaimed.

“Debt-to-income hits fresh record,” Reuters said.

But while debt-to-income levels seem frightening, CIBC argues it’s anything but.

“In many ways this ratio is designed to rise. In the past 25 years, the debt-to-income ratio fell only twice,” Tal wrote. “In a normally functioning economy, debt will rise faster than income.

“For the ratio to fall notably you need a significant shock such as the US financial crisis which led to the US debt-to-income ratio falling from over 160% to 140%,” he continued. “Is the ratio rising too fast? Not really. Total real household debt is now rising by just over 4% (year-over-year)—a rate that is in line with the performance seen during the jobless recovery of the 1990s.”

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COMMENTS

  • by Dizzy 2017-03-17 3:57:45 PM

    So a normal functioning economy is for debt to increase? Of course that is normal for a bank as they make money and profit from debt. This debt is separate from mortgage debt so mortgage debt is not included in this ratio.

    But who can argue with a bank that spending .67 cents more on every dollar of any disposable income is not a good thing. And I suppose that comparing debt to income ratio does not mean a thing. So where does the money come from to pay down or even just pay the debt if not from income? If not from income then where? I can only assume that this person has spent years as a politician.

    So when people can no longer afford to service their debt and begin defaulting on payments on such debt as lines or credit and credit cards and personal mortgages, all will still be good for the healthy economy.

  • by Dizzy 2017-03-17 4:01:30 PM

    So a normal functioning economy is for debt to increase? Of course that is normal for a bank as they make money and profit from debt. This debt is separate from mortgage debt so mortgage debt is not included in this ratio.

    But who can argue with a bank that spending .67 cents more on every dollar of any disposable income is not a good thing. And I suppose that comparing debt to income ratio does not mean a thing. So where does the money come from to pay down or service the debt if not from income? If not from income then where? I can only assume that this person has spent years as a politician.

    So when people can no longer afford to service their debt and begin defaulting on payments on debt such as, lines of credit and credit cards and personal mortgages and auto mortgages, all will still be good for the healthy economy.

  • by Hans 2017-03-18 10:41:42 AM

    The debt issue is totally dependant on how the debt is managed. If most of your debt is on appreciating assets, and is not in arrears, then the ratio means very little . On the other side ,if most of your debt is personal , also called liabilities on depreciating items then your ratio of debt to income is a lot more important .

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