20 Jul

Need motivation for cutting debt? Look stateside


Posted by: K.C. Scherpenberg


Personal Finance

Need motivation for cutting debt? Look stateside

ROB CARRICK | Columnist profile | E-mail

From Wednesday’s Globe and Mail

The debt problems of the global financial system are your problems.

So pay down your credit card, credit line and mortgage. Making your household balance sheet tidier has the fortunate spillover effect of saving our economy.

From what? Just look at what’s happening in the United States: The housing market is a disaster, weak consumer spending has crippled the economy, and politicians are grappling with how to fix things through a mix of government spending cuts and tax increases.

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The Bank of Canada gave you another reason to get your debts in line on Tuesday, when it signalled, in its typically obscure way, that interest rates will rise in the foreseeable future. The bank did this by deleting the world “eventually” from a discussion of rate increases.

Rising rates will hit you in two stages. The first is instant – when the central bank raises its overnight rate, the major banks increase their prime lending rates by an identical amount. That, in turn, means higher interest charges for people with variable-rate mortgages, lines of credit and floating rate loans.

The second phase is when mortgages and other borrowing products with fixed rates start to rise. If you’re buying a house or renewing a mortgage in the next couple of years, you’re going to pay more than you would now. How much more remains to be seen.

You’ve heard this before. For the past 18 months or so, the nagging has been non-stop from Bank of Canada Governor Mark Carney, the federal finance minister and this column, among others, about the need to pay down debt before rates rise.

And you’ve listened. CIBC World Markets reported last week that debt levels are rising at their lowest pace since 2002. If you take mortgages out of the calculation and adjust for inflation, Canadian borrowing has slowed to the lowest level since the early 1990s. Should current credit trends persist, we could see non-mortgage borrowing actually decline in the second half of the year. As for mortgage borrowing, that should take care of itself if predictions about a correction in housing prices are right.

All in all, we’re doing okay here in Canada. An orderly decline in borrowing is much preferred to what’s happening in the United States.

A report in The New York Times on Sunday documented how American consumers have become miserly after years of binging on debt. The decline in spending is so drastic that it’s being blamed for stagnant job growth. Measured in terms of sales per 1,000 people, housing is down 24 per cent since 2007, automobiles are down 26 per cent and washers and dryers are down 26 per cent.

The Economist reported recently on how almost one in seven Americans was using food stamps as of April. The U.S. unemployment rate was 9.2 per cent in June, double what it was five years ago, before the global financial crisis began to develop.

This is the background that explains the political battle in Washington about whether to increase the ceiling on government debt. The United States can finance its operations and meet its debt obligations to bondholders around the world – it just needs to borrow more money to do it.

There has been a lot of worrying lately about Greece and other European countries that are spending more then they’re generating in revenue. Now, it looks like China could be added to the list of countries with debt issues. In a report issued Tuesday, TD Economics said questions are being asked about the quality of the loans issued by Chinese banks in a flurry of lending that was meant to help stimulate the economy following the financial crisis.

Reducing your own debts is how we avoid these kinds of problems here in Canada. Each individual with excess debt is a stress on the system. Add enough stress and we get the stories playing out in other countries.

There have been a few times in the past couple of years where interest rates seemed poised to rise and then didn’t because of global financial uncertainty. So the Bank of Canada’s time frame for rate increases is still somewhat open-ended. Even when rates do start to rise, it will likely be in small increments of one-quarter of a percentage point.

That means you still have time to reduce your debts. Start with your credit cards because they have the highest interest rates, and work down to your loans, credit lines and your mortgage. Every dollar in debt you pay off makes our economy stronger.