Data released yesterday show that household debt* as a proportion of household disposable income in Canada declined for the third consecutive quarter.

Household debt went from 179.2% of disposable income in the third quarter of 2023 to 178.7% in the fourth quarter of 2023.

The reason for the recent decline is telling: high interest rates led to relatively sluggish mortgage borrowing in the fourth quarter. As a result, a 1.3% increase in disposable income was able to more than offset a 1.0% increase in debt.

That all sounds fairly encouraging given the high interest rate environment we are in. Upon closer inspection, however, there are some red flags.

First, the debt service ratio,** has crept up 1.5 points from 13.5% at the start of 2021 to 15.0% at the end of 2023.

Second, the ratio of interest payments to disposable income has gone by 3.5 points over the same period from 6.0% to 9.2% (see the chart below).

Third, both mortgage and non-mortgage debt is expected to rise this year, putting upward pressure on the already elevated debt service ratio.

Fourth, although we are anticipating some cuts to the Bank of Canada’s trendsetting interest rate in the months ahead, current debt is being taken on at current interest rates, which remain high. At the same time, disposable income is expected to grow at a slower pace.

Putting all this together, the amount of disposable income Canadian households will have to spend on consumer goods and services in 2024 will be constrained by the rising cost of servicing a large amount of debt.

*Includes consumer credit, mortgage debt, and non-mortgage loan liabilities.

**Total obligated payments of principal and interest on credit market debt as a proportion of household disposable income.

Answer to the previous trivia question: According to the International Monetary Fund, Venezuela had the highest inflation rate last at 360%.

Today’s trivia question: What is the difference between simple and compound interest?