Household debt levels have experts and the Bank of Canada worried once again as reported in the Vancouver Sun recently. Accordingly, it’s up to 163.6 percent of disposable income, mainly from mortgages, Statistics Canada has reported.

The debate returns from certain experts about what Canadians can and cannot afford.

Afford is one of those great mysteries in personal finance. How do you measure this? Is there one size that fits all i.e. is there a formula, an objective test that could be applied to everyone, as in all income groups?

The answer: No. This great mystery goes back to the earliest days of my banking career. People were assessed on the basis of their individual merits. For mortgages, it was a little different as the old 30% gross debt ratio and down payment were not negotiable… today the down payment varies according to whether or not it is a CMHC approved mortgage, and how much consumer debt you have.

Still, the question of what you could afford to pay on housing, for a car, for food, for entertainment and how much consumer debt can you afford were all vague and left up to the individual to figure out. 

This is a very interesting question today in 2014 when we carry $525 billion in consumer debt (excluding mortgage debt) whereas in 1975, it was $20 billion. It appears that the new millennial consumer can afford way more debt today than in 1975. (Sic)

One expert, in the recent article on household debt referred to above, mentioned that mortgage debt rose 1.4 per cent to $1.17 trillion this year while disposable income rose 1 per cent. Of course this introduces another highly abstract financial construct: disposable income. What does that mean?

Unfortunately the definition of disposable income is muddled with inconsistencies and often is confused with discretionary income.

One definition of disposable income suggests that this is what is left over after you subtract the gross income from taxes.

Another definition subtracts all non-discretionary expenses such as corporate pension contributions, all statutory deductions, medical and dental insurance contributions etc. from the gross income. This is the amount that the wage earner actually receives.

Under the Surplus Income rules in a bankruptcy: (now called available income) is calculated by:

1.      The family unit's available monthly income is determined by subtracting from the family unit's total monthly income the monthly non-discretionary expenses applicable to the personal and family situations of both the bankrupt and the bankrupt's family unit:

  1. child support payments;
  2. spousal support payments;
  3. child care expenses;
  4. expenses associated with a medical condition;
  5. Court-imposed fines or penalties that are in the process of being paid;
  6. expenses permitted by the Income Tax Act (or similar provincial legislation) that are a condition of employment;

This in my view, is a much more accurate definition of disposable/available income or what is better described as discretionary income – what the individual has available to purchase, buy, rent and so on. And, unlike the normal definition of discretionary income, it includes child care expenses, child/spousal support payments and expenses associated with a medical condition – all expenses that people must face if they have child/spousal support or otherwise are raising children.

How much disposable/discretionary/available income do people need to meet the essential costs – and/or raise children? We don’t know.

How much debt can we afford? We still don’t know.

Is consumer debt going up? Yes.

Is household debt going up? Um, yeah, well, it looks like it. In the language of the above article, credit-market debt (a new term) such as mortgages rose to 163.6 per cent of disposable income, from a revised 163.1 per cent in the first quarter. The measure reached a record 164.1 per cent in the third quarter of last year, and has averaged 119.7 per cent since 1990.

The Bank of Canada sees the risks still there with household imbalances but believe they are evolving in a constructive way.

Some banks, on other hand, see the risks and strains with consumer finances as a good reason to raise interest rates… next year…

The bottom line folks is this. We must determine a realistic financial plan of expenses, one that does not require further borrowing and one that addresses the outstanding consumer debt we owe. Any increase in interest rates would seriously impact middle and lower income groups who, presumably, owe most of the consumer debt. Looks like we have just been warned.

Remember, if you are experiencing financial difficulties do not wait. Call Solutions Credit Counselling at 1(877)588-9491 or fill out our Debt Consolidation Questionnaire and get your Free Credit Counselling Advice today.

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