Rising debt service costs are only starting to be felt by Canadian households

Even as the Bank of Canada comes to the end of its rate hiking cycle, household debt service costs will continue to rise, hitting new highs over the next year. Even with slowing household debt growth and some increase in average amortization, debt payments are set to rise by two percentage points of disposable income, exceeding the pre-pandemic peak of 15 per cent, says a new report by TD Economics.

Mikhail Nilov

The increase in debt service costs will come entirely from higher interest payments, which, on average, are expected to rise by 60 per cent by the end of 2023. Meanwhile, the share of total debt payments going toward principal will drop, as repayment slows, added the report.

Its highlights include:

• The Bank of Canada nearing the end of its rate hiking cycle. From 0.25 per cent in February, the overnight rate has risen to 4.25 per cent. TD anticipates another 25 basis points in additional hikes, taking the overnight rate to 4.5 per cent in early 2023;
• While interest rates have been rising since the start of this year, the impact on household’s bottom lines has only just begun. Debt service costs rise with a lag as mortgages and loan payments are renewed at current market rates;
• From a starting point of 13.3 per cent of disposable income in the first quarter of 2022, debt service ratio increased to 14 per cent in the third quarter. The debt service ratio is likely to rise by another two percentage points, eclipsing the pre-pandemic peak by the second half of next year;
• The increase in debt service will come entirely from higher interest payments. As already witnessed in the third quarter, payments on principal will likely continue to trend lower, as qualifying households extend amortizations and slow non-mortgage debt repayment to mitigate the increase in required monthly payments;
• Households will need to adjust spending and saving in order to accommodate higher debt payments. Fortunately, the personal saving rate is elevated relative to its pre-pandemic level, providing a cushion. Still, TD expects consumer spending growth to stall over the course of 2023 and much of the excess saving built up during the pandemic to be drawn down by the rise in debt service costs.

(Mario Toneguzzi is Managing Editor of Canada’s Podcast. He has more than 40 years of experience as a daily newspaper writer, columnist, and editor. He worked for 35 years at the Calgary Herald, covering sports, crime, politics, health, faith, city and breaking news, and business. He works as well as a freelance writer for several national publications and as a consultant in communications and media relations/training. Mario was named in 2021 as one of the Top 10 Business Journalists in the World by PR News – the only Canadian to make the list)