Canada Debt: How much is too much?

With inflation, rising cost of living and other economic constraints, Canada debt is becoming a concern. You might be in the process of a personal debt review and be concerned with your debt amount. The reasonability of debt load depends on many personal finance factors. Continue reading to learn more about assessing your debt.

Canada debt

How much debt does the average Canadian have?

Excluding mortgage debt, the average Canada debt per individual is $20,739. By this logic, the average household debt in Canada is about $41,500. When you factor in Canada mortgage debt, the average Canadian is carrying about $75,000. That’s a high amount for average Canadian debt!

Keep in mind that debt load depends on many variables. A big one is where you live in Canada. Cities like Vancouver and Toronto have higher costs of living than smaller cities and towns. In addition, your life’s circumstances can alter your debt load, such as recently losing a job or experiencing a reduction in income.

Is it normal to have debt in Canada?

Yes, it is normal to have debt. Most people carry a debt balance on their credit card or line of credit from month to month. In addition, many Canadians finance their car purchase, take out student loans or hold a mortgage.

Just because carrying debt is normal, that doesn’t mean it’s okay. But on the contrary, debt isn’t always bad. In fact, debt can help you achieve your long-term financial goals. With that being said, debt can quickly get out of control if you don’t make informed decisions. There are many nuances to how reasonable debt is.

Types of Canada Debt

In the grand scheme of things, there are two types of debt: secured and unsecured debt.
Secured debt is backed by collateral. If the borrower defaults on the loan, the lender can seize the assets put up as collateral to cover the owed balance. Since these loans are less risky to the lender, the borrower usually receives a lower interest rate in exchange. Common types of secured debt include car loans, mortgages, equipment loans and home equity lines of credit.

Unsecured debt is not backed by collateral. These loans are more risky to the lender so they tend to charge higher interest rates on this type of debt. Common types of unsecured debt include credit cards, lines of credit, student loans, business loans and personal loans.

How much debt is considered ‘too much’?

Per the statistics above, you might be wondering, is $20K of debt a lot? A reasonable debt load is determined based on the individual’s financial circumstances. The main thing to consider is income in relation to debt. An individual with higher income can afford to take on more debt compared to a person with lower income. Let’s take a deeper look below.

Canada Debt: Good debt vs. bad debt

Not all debt was made equal! Good debt is any kind of financing you took on to build wealth and increase income over time. For instance, purchasing a home to build equity or going back to school to get a higher paying job is good debt. On the other hand, bad debt is any kind of financing taken on to purchase things that don’t enhance your financial wellbeing. Consumer debt, such as credit cards or other materialistic purchases don’t tend to build wealth or increase income over time. In fact, at the end of 2021, total credit card debt in Canada was up 14.4% year over year. As well, average monthly credit card spend per person is $2,205. That means a typical person has an average credit card debt in Canada of just over $2,000 at any given point in time.

Keep in mind that this is an overgeneralization – the difference between good and bad debt has much more implications. For example, buying a house is generally a good financial decision, but not if you don’t have enough money to afford a mortgage. Or if the house is not a good investment because it has issues like mold or is prone to flooding.

What are the signs of having too much debt?

The best way to assess if you have too much debt is through ratio analysis. By looking at analytics, you can better understand how you are leveraging wealth. The most commonly used ratio is the debt-to-income ratio. Let’s explore below.

Debt-to-income ratio

The debt-to-income ratio measures your monthly debt obligations against your net income after taxes. A good debt-to-income ratio in Canada is 35% or less. If your debt-to-income ratio is higher than 43%, you may be carrying too much debt.

Most Canadian banks assess your debt-to-income ratio as a part of their approval process. They would want you to have 42% or lower, but it really depends on the lender and what financial product you’re applying for. For a mortgage, lenders would likely want a lower debt-to-income ratio since the payments are a substantial part of your budget.

How to calculate your debt-to-income ratio

To calculate your debt-to-income ratio, you need two inputs: your monthly income and monthly debt payments. Your monthly income is your pay cheque, if you are an employee. If you are a contractor, use two thirds of your regular pay to account for taxes as an estimate. Your expenses will include things like:

Once you have calculated these inputs, your debt-to-income ratio is your monthly expenses divided by your pre-tax income. The output value is a percentage.

For example, if your monthly debt payments total $1,000 and your monthly income is $4,000, your debt-to-income ratio for Canada debt would be 25% ($1,000 / $4,000).

Lowering your debt-to-income ratio

To lower your debt-to-income ratio, you can do two things: raise your income and lower your debt. By increasing your monthly after tax income, the ratio will go down because you have more funds to cover your debts.

Alternatively, you can lower your debt by consolidating credit, refinancing or eliminating debt all together. By consolidating credit or refinancing, you can achieve a lower monthly payment. However, consolidating and refinancing usually means you pay more interest over the course of the loan in exchange for a lower monthly payment. If you have some savings, it could be worthwhile to completely pay off debts so you no longer have the monthly payments. All of these things reduce your monthly debt payments which lowers your debt-to-income ratios.

Credit utilization ratio

Another popular ratio to assess debt is the credit utilization ratio. This ratio is also a component of your credit score. The lower your credit utilization ratio is, the better your credit score will be. For credit score purposes, an ideal credit utilization ratio is 30%. However, for overall debt, the best ratio is 10% or less. Between 10% and 30% is a decent ratio.

How to calculate your credit utilization ratio

To calculate your credit utilization ratio, you need two inputs: your total credit available to you and the outstanding balance. For both amounts, consider your credit cards, lines of credit and loans. Omit your mortgage from this calculation. Once you have the two amounts, the ratio is calculated as total outstanding balance divided by the total amount available. This will return a percentage.

For example, let’s say you have a total car loan of $25,000, but $10,000 outstanding. In addition, you have a credit card limit of $5,000 and $800 outstanding. Your total credit available would be $30,000 and the outstanding balance would be $10,800. Your credit utilization ratio would be 36% ($10,800 / $30,000).

Lowering your credit utilization ratio

To lower your credit utilization ratio, you can either increase the credit available to you or pay off debt. It’s best if you can pay off debt and maintain that position since it’s more sustainable in the long run. Taking out new debt may tempt you to spend more down the road. However, each individual is unique.

20/10 rule

The 20/10 rule is another metric used to assess debt levels. The first part refers to aiming to keep total borrowing payments below 20% of your annual after-tax income. This percentage should reflect credit cards, personal loans, car loans, student debt and other similar kinds of debt. This figure excludes mortgage debt. This is because owning real estate tends to build equity. It’s a cost that is increasing your wealth over time.

The second half of this rule considers monthly payments and cash flow. Your goal is to keep payments on all loans and credit cards at 10% or less of your monthly after-tax income. As with the 20% portion, mortgage payments are excluded from this figure.

Trouble making payments

As you can see, calculating various ratios is a lot of work! There is a more simple way to assess whether you have too much debt. If you’re struggling to make payments on time and in full each month, you are probably overleveraged. Finances don’t have to be this stressful, now might be the time to say, “I got to pay my debt!”

Debt Canada calculators

Below are some free tools you can use to evaluate your debt.

How to get debt relief in Canada

If you’re feeling overwhelmed by debt, there are resources available to help you! Below is an array of resources for debt assistance in Canada.

Credit counseling

Credit counseling is the process of meeting with a credit specialist. They will help you better understand finances and help you create a plan to get your debt in a healthier position. Credit counselors may help you create a budget, advise you on what financial products will improve your financial position, and provide you with general financial resources. In addition, there are debt advisors in Canada who specialize in eliminating owed amounts.

Debt Consolidation

Debt consolidation in Canada is the process of combining multiple debts into one loan. This means only one monthly payment to worry about, as opposed to many. People often find this more manageable when paying down debt. In addition, debt consolidation often results in a lower overall interest rate and lower monthly payment, especially if credit card debt is involved.

Consumer Proposal

A consumer proposal is a formal, legally binding process to resolve Canada’s debt. To participate in a consumer proposal, you must work alongside a Licensed Insolvency Trustee (LIT). You will work with your LIT to come up with a proposal offered to creditors to pay a smaller percentage of what is owed to them, an extension of time to pay off debts, or a combination of both.

Bankruptcy

Bankruptcy is a formal, legal process to manage Canada debt administered under the Bankruptcy and Insolvency Act. It should be a last resort option for managing debt. Usually, a bankruptcy takes place when debtors are completely overwhelmed by their debts. It is the only true form of debt forgiveness in Canada. To participate in a bankruptcy, you must work alongside a Licensed Insolvency Trustee (LIT). They usually take control of your assets to resolve debts, but the debtor is completely debt-free by the end of the process.

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