Danger of debt and rising interest rates

Ican vaguely understand the temptation. I mean, I have a son, and he was once nine years old. It wasn’t unusual for him to have some sort of dried food on his face, or dirt, or maybe a runny nose that bothered his parents clearly much more than it did him.

So, looking back, I sort of empathize with the inclination my mother had to constantly clean my face. And, since I was once that little boy, I can also recall wondering what all the fuss was about. It was one thing to sit still long enough for mom to scrub my face, but quite another to endure the ultimate horror.

She would get this look of incredulity in her eyes and a fierce determination would overshadow her usual graces. A fever would overtake her as she pulled out a tissue from her purse and licked it, then scrubbed my face with the spit-soaked Kleenex, with special emphasis around my nose and mouth. The worst of it was the lingering smell of spit it left on my face afterward.

Blech.

Sometime during my 10th summer, I discovered the joy of dirt bombs. We had gone through a hot, dry spell, and the dirt at a local park had given way to a powdery brown dust, which if dropped from above my head would make a sort of mushroom cloud all around me. I mean, how cool is that?

On coming home, my mother sent me straight to the bath, which seemed a bit cruel to me, but far better than another spit wash, so I went in. We had just one bathroom, and shortly before I was dressed she begged to come in and use the facilities.

“I’m not dressed yet!”

“Oh you have nothing I haven’t seen before.”

“Pardon me!”

The thought was worse than a spit bath. That somehow this woman had ever seen me stark bufferdoodles, that I was born without a bathing suit never occurred to me at that moment. Nor the mechanics of diapers and little boy baths.

Getting caught naked and vulnerable is a shock at any age and to any investor.

In my lending days, a common safety practice, especially in low rate environments, was to test our loans against the possibility of increasing interest rates. It is one thing to qualify for a mortgage when rates are low, but how would the borrower manage if rates went back up to historic norms?

Thanks to RBC’s team of economists, we have some data and commentary relevant to this very question, out just this week, and if you will excuse the pun, I borrow from it here.

Interest rates are on their way up, as a Canadian economy that’s nudging up against capacity limits reduces the need for policy stimulus. But not all parts of the country will be affected equally. Given expensive housing markets in B.C. and Ontario, it would be natural to assume that households in those provinces would be the most vulnerable. However, our research shows that Albertans would see the biggest increase in debt-service payments in Canada – more than $1,200 a year, on average – if interest rates rose by one percentage point. Households in B.C. and Ontario are also more indebted than the national average, but Albertans carry the heaviest debt loads. A booming provincial economy and strong income gains between 2011 and 2014 emboldened households in Alberta to buy homes (sales growth averaged over 10 per cent per year in that period) and accumulate significant debt, leaving them with high debt loads when incomes dropped following the plunge in global oil prices.

Albertans are also holding more short-term mortgage debt than other Canadian households, although higher-than-average incomes offer them some breathing room.

How much debt are we talking about? Albertans’ total liabilities rose from $164,000 per household on average in 2010 to $192,000 in 2016. These numbers include households that are debt-free, so actual outstanding balances for those carrying debt are even higher. Mortgages took up the lion’s share of Albertans’ household debt. The average household was carrying a mortgage of $124,000 in 2016, up from $96,000 in 2010. Other debt such as term loans, lines of credit and leases amounted to $68,000 in 2016, unchanged from 2010.

B.C. households carried the second-heaviest average debt load in the country in 2016 at $174,000, followed by Ontario households at $154,000. Mortgages made up 69 per cent and 67 per cent of those totals, respectively, and accounted for three-quarters of the increase since 2010.

Albertans face the biggest increase in debt-service payments. Albertans already spend the most among all Canadians to service their (relatively larger) debt. In 2016, the average debt-service payment was $15,300 per Alberta household (including both principal and interest). This exceeded the $13,700 paid by British Columbians, the $12,600 paid by Ontarians and the average of $11,600 by Canadians on average. We estimate that, everything else remaining constant, a one- percentage-point rise in interest rates ultimately would raise annual debt service payments by more than $1,200 on average for Alberta households. This compares to estimated increases of $1,100 in BC, $1,000 in Ontario, and $800 or less in all other provinces. The lesson?

Don’t be a statistic. Avoid the full facial spit bath and keep your debt down to manageable limits.

Mark Ryan is an investment advisor with RBC Dominion Securities Inc. (Member–Canadian Investor Protection Fund), and these are Ryan’s views, and not those of RBC Dominion Securities. This article is for information purposes only. Please consult with a professional advisor before taking any action based on information in this article. Ryan can be reached at mark. ryan@rbc.com.