The Complete Guide to Debt in Canada

Are you in debt and looking for ways to manage it? Or are you simply interested in learning about the ins and outs of borrowing? Either way, this guide is here to help you navigate the world of debt in Canada.

While it’s true that borrowing can be a necessary part of life, it’s important to be mindful of the type of debt you take on. Not all debt is created equal – some forms of borrowing can actually help you build wealth and achieve your goals, while others can be a financial burden. By understanding the difference between good debt and bad debt, you can make informed decisions about when and how to borrow.

Each type of debt, whether a credit card, student loan, mortgage or personal loan – comes with its own set of terms and conditions. It’s important to carefully consider these factors before borrowing, as they can have a significant impact on the overall cost of your debt.

Good Debt vs. Bad Debt

Some people argue that there is no good debt, while others say borrowing allows you to improve your financial situation and well-being significantly. There is a difference between borrowing to improve your situation and borrowing to fund a lifestyle you may not be able to afford.

Good debt

Good debt is generally any debt that helps you improve your financial situation and well-being. In addition, good debt gives you a way to take advantage of opportunities such as paying for an education, buying real estate or other assets, starting a business, or buying investments.

Assets

Borrowing to buy assets can be a good decision if done wisely. Assets are things you own that you expect to provide a benefit in the future. A home can be an asset because it may appreciate, and you can sell it if necessary. Education can be an asset because it can give you the skills and knowledge you need to increase your earning power.

There is no guarantee, of course, that a home will appreciate, education will get you a good job, or a business will succeed. However, in most cases, these things will give you a better chance of building wealth than you would have without them.

Bad debt

Bad debt is the debt you use to pay for things with no long-term value. This type of debt is usually a result of consumption like clothes, dining out, or the purchase of assets that depreciate quickly. One indication that you have bad debt is if you’re paying for items long after they have no value.

Types of Debt

Different borrowing products exist for different borrowing needs. Some are for long-term borrowing, which can take several years or decades to repay, such as a mortgage. Other credit products like overdraft protection are for short-term needs. Most household debt in Canada consists of a mix of mortgages, car loans, loans, lines of credit, credit cards, and overdraft protection.

Two main categories of debt are fixed and revolving. Fixed credit is typically advanced in one lump sum, has a fixed or variable rate, and is amortized over a year or more. Fixed credit includes mortgages, home loans, car financing, and loans.

Revolving credit has a maximum credit limit that you can choose to access or not. If you use the limit and pay it down or off, you can borrow back up to it again. These products have no specific payoff date. Instead, you make minimum payments based on the amount outstanding. Lines of credit, credit cards, and overdraft protection are revolving credit products.

Mortgages and Home Loans

A mortgage or home loan is usually money borrowed from a bank or credit union to buy a home. If you already have a home, you can use the equity in your home to get a mortgage loan for many purposes. You could use your home equity to pay for renovations. Other reasons you might get a home loan are to consolidate debt, pay for a wedding, pay medical expenses or buy a second property.

Mortgages and home loans can have a lot of flexibility. Their options allow you to set up payments to suit your budget. Mortgage interest rates are often lower than other credit products. Common features of mortgages are:

• Large loan amount-minimum mortgage amounts are usually $20,000 or more
• Mortgages are secured by your home, which means the lender can repossess and sell your home if you don’t make your payments
• You can have up to 25-30 years to pay off your mortgage loan
• Your payments can be weekly, bi-weekly, semi-monthly, or monthly
• You can choose an interest rate for a term ranging from 6 months to 10 years, depending on the lender’s policy
• Once the term expires, you can choose to pay off the mortgage or renew the mortgage at the available rates
• Most mortgages have prepayment options which allow you to pay more so you can pay the mortgage off faster

Many lenders offer mortgages in Canada. You can apply for a mortgage at a bank, or credit union, through a broker, at an alternative lender, or with a private lender. The terms, conditions, and interest rates will vary, so reviewing the mortgage offers carefully is essential.

Car Financing

Vehicles are a big ticket item that many buyers plan to finance. Research indicates about 40% of buyers plan to finance their purchase through a dealership. Another 10% of buyers plan to lease their vehicle, and 32% plan to pay for the car with cash.

Financing your vehicle means that you get a loan to make the purchase. Most people get their loan through the dealership, but you can get a car loan through your bank or a credit union. You might need to provide a down payment when you finance your car. The loan funds the balance of your car purchase.

Typically, you will have a repayment period of one to seven years at a fixed interest rate. In some cases, you can get an eight-year amortization. Your payments can be monthly, weekly, bi-weekly, or semi-monthly. The car is held as collateral and can be repossessed if you don’t make your payments. Once you pay off the loan, the vehicle is yours. Car loans can be paid off early without penalty in most cases.

Personal Loans

You can use personal loans for almost any purpose, including buying a car. You can also use a personal loan to consolidate debt, for medical expenses, to pay for a wedding or a vacation, or many other purposes. Once you have loan approval, the financial institution will advance it in one lump sum. Sometimes, they might make payments directly, such as when paying off and closing other debts. However, the lender usually deposits loan proceeds in your bank account.

You can choose how often you want to make payments, as with mortgages and car financing. They can be monthly, weekly, bi-weekly, or semi-monthly. Loans usually have an amortization of one -five years, meaning you’ll pay off the loan in that time.

Lines of Credit

A line of credit is a revolving credit product. You’ll have a maximum credit limit you can use or choose not to use. You will be charged interest on your balance owing and your minimum payment is based on the amount owing. The minimum payment can be interest only, 2% of the outstanding balance, or 3% of the outstanding balance. As long as you make your minimum payments on time, you can continue to use your account.

Lines of credit often have higher credit limits than credit cards and lower interest rates. They are often used to pay for large purchases such as a vehicle, renovations, a wedding, or a vacation. Some are also specifically for investment purposes, such as an RRSP line of credit. The most common way to access your line of credit is to connect it to your banking and transfer the amount you want from the line of credit to your bank account.

Credit Cards

Credit cards are a part of our everyday life. According to the Canadian Bankers Association, there are over 76.2 million Visa® and Mastercard® cards in Canada. So it’s safe to say that most adult Canadians have a credit card.

Credit cards are a revolving credit product. You can spend up to your maximum limit and then reassess the limit once you pay the card balance down or off. While credit cards are similar to lines of credit, they differ in a few ways.

Credit card limits tend to be lower than a line of credit, and the interest rates on credit cards are usually higher, sometimes significantly. Minimum payments are often interest plus $10, but this depends on the credit card company’s policy and where you live. In Quebec, for example, your minimum credit card payment is 3.5% of the outstanding balance if you had your card before August 1, 2019. However, if you received your credit card after that date, your minimum payment is 5% of the balance owed.

You can use your credit card to pay for goods and services online, in person, or over the phone. However, any unpaid balance after the payment due date is usually charged a high interest rate.

Overdraft Protection

Overdraft protection is added to your bank account. It allows you to overdraw your account if you spend more than your available balance. Interest rates for overdraft protection are typically high, and lenders often charge a fee if you use it. You may also incur a fee for having an overdraft on your account. Your financial institution may require you to cover your overdraft monthly. Once you have paid your overdraft, you can use it again.

Canadian Interest Rates

In Canada, the Bank of Canada sets lending rates. The Bank of Canada will adjust rates based on economic conditions and the policies they want to implement.  Currently, the Bank of Canada is raising interest rates to cool down the economy to bring down inflation. As a result, the Bank of Canada increased interest rates from .25% to 4.25% from March 2022 to December 2022.

Lenders respond to rate increases from the Bank of Canada by increasing the rates they charge their customers on loans, mortgages, and lines of credit. However, credit card rates are less likely to change.

Interest Rates

An interest rate is a rate the lender charges you to use their money. Credit products like loans and mortgages include interest as part of the payment and don’t itemize it separately. Lenders disclose the amount of interest you will pay on a “cost of borrowing” disclosure form. However, with revolving credit products like credit cards and lines of credit, the interest you’re paying is shown separately but is still part of your payment.

The interest rate your lender charges you is based on several factors. Products like loans and mortgages often have lower rates than revolving credit products. If you have a good credit rating, you might qualify for a lower rate than if you have a poor credit score. A loan secured with an asset like real estate or investments usually has a lower interest rate than an unsecured loan.

Interest rates can be fixed or variable. A fixed rate means the interest rate is set for the term and will not change until the term expires or the loan is paid off. An example of this is a mortgage. You could have a five-year term with an amortization of 25 years. It will take 25 years to pay off the mortgage, but your interest rate will remain the same for five years. Once the term expires, you can choose a new term and rate.

Prime Rate

Major financial institutions set the prime rate. They base the prime rate on the Bank of Canada’s overnight lending rate. The overnight lending rate is the rate financial institutions use to lend money to one another for one day. If the overnight lending rate is 4.25%, for example, the prime rate could be 6.45%. The overnight lending rate is the rate lenders use when charging interest rates for their products.

Not many products will have an interest rate of the prime rate. Revolving credit products often will have a rate of prime plus a surcharge of additional interest, like prime plus 4%. If the line of credit is secured, it could have a rate of prime minus .5% or 1%.

Fixed rates

Fixed rates refer to the interest rate on your loan or mortgage. The rate is fixed and will not change for the term of the loan or mortgage. The advantage of a fixed rate is your payments are predictable and will not change for the term. The disadvantage of a fixed-rate loan or mortgage is the rate can be higher than on a variable-rate product. The other disadvantage is if interest rates are going down, you are locked into your fixed rate.

Variable Rates

Mortgages, lines of credit, and loans can have variable interest rates. The rate is tied to the prime rate. As the prime rate changes, either increasing or decreasing, your rate will increase or decrease too. If the prime rate remains the same, your rate will not change. Variable rate products can be prime plus a higher rate or prime minus a lower rate. As an example, lines of credit could be prime rate plus 4%, while a mortgage might charge a variable rate of prime minus 1.5%. Variable rates can be lower than fixed rates, but if rates increase, that could change. As a result, payments are less predictable than with a fixed rate.

Mortgage Interest Rates and Loan Rates

Interest rates on mortgages and loans can be fixed or variable. Two factors that significantly impact the cost of your loan or mortgage are the interest rate and how long you take to pay the mortgage or loan off. Keeping your interest rate as low as possible and your amortization as short as possible will reduce your cost of borrowing. Shopping for the best rate can save you money, and prepaying your loan can reduce costs.

Interest Rates for Credit Cards, Lines of Credit, and Overdraft Protection

Interest rates for credit cards and overdraft protection are usually not variable but can change if the lender decides to increase the rate. Rates on these products are typically quite high. If you can avoid carrying a balance on your credit card or using overdraft protection, you will save money on interest costs.

Lines of credit are variable rate products that move as prime rate changes. A line of credit not secured by any assets usually has a premium added to the prime rate, such as prime plus 4%. However, lines of credit secured by an asset will often have a lower premium, such as 1%, or the rate could be prime minus .50% or more.

How High is Debt in Canada?

Debt in Canada is measured in several different ways including average debt, household debt, and consumer debt.

Average debt in Canada

Canadians currently have an average of $21,128  in non-mortgage debt. This figure includes credit cards, loans, and lines of credit. This is an increase of 8.2% from a year ago, indicating that consumer debt is increasing. According to an Equifax report in December 2020, the average Canadian owes $74,897, including mortgages.

Household debt

Household debt is the combined debt total of all the people living in a household. Total household debt in Canada was USD 2,033.5 billion in September 2022. This is slightly lower than in May 2022, when Canadian household debt reached a record high of USD 2,165.8 billion.

Consumer debt

Consumer debt is the debt you incur for goods and services you consume. It includes mortgages, loans, car loans, credit card debt, student loans, auto loans, lines of credit, and payday loans. Total consumer debt in Canada in September 2022 was $2.32 trillion in Canadian dollars, representing an increase of 8.2% since the second quarter of last year. Two reasons for the increase in consumer debt are the increase in the cost of living and pent-up demand as a result of the pandemic.

What to do if Your Debt is Overwhelming

Debt in Canada is very high, and some borrowers find it challenging to make payments and afford the things they need. If you are overwhelmed by the amount of debt you have, there are solutions available.

John Adamson, a Licensed Insolvency Trustee and his team at Adamson and Associates can help you find solutions to deal with your debt. Call Adamson and Associates at 519-310-5646 for a free consultation and a fresh start.