A good debt, it’s there

Une bonne dette, ça existe

In the long run, it is annoying to see the statistics on the debt quoted wrongly and through. There is not a report on the financial health of households that don’t remind us how the families are at the edge of the hole, based on a figure that nobody seems to understand : the debt-equity ratio.

“Oh ! The debt ratio of Canadians has smashed 170 % ! “Yes, it strikes the imagination to know that it must 1,70 $ for each dollar of after-tax income. And as it climbs from 2000, it doesn’t take much to conclude that it will end necessarily in hell financial…

It is the fault of the mortgage, and it is beautiful !

Our debts are made up of more than 80 % of mortgages, it is this which explains that the evolution of the ratio of household debt following the curve of the price of the houses. If the values of the real estate are soaring in recent years, is that demand rose faster than supply. It goes on and on.

Why is it that people are more likely to want to access the property ?

Why are they willing to pay more ? Because they work in mass, but mostly because the mortgage rates are to the floor for more than a decade.

It is important to know that when interest rates go down, you can borrow more without adding to what is called the ” debt service “, that is to say the monthly payments necessary to meet its financial commitments.

For example, to repay over 20 years a $ 100,000 mortgage with an interest rate of 3.5 %, it is necessary to repay around $ 575 per month. The monthly payments would be the same for those who contract a loan of $ 75,000 amortized over 20 years at a rate of 7 %. The two face the same financial obligations, but the first displays a high level of debt much higher.

Some evoke with nostalgia the real estate prices of the 1990s. With the Exception of the downpayment needed today, the houses were not so much more affordable at the time. The interest rates were so much higher, and the unemployment rate exceeded 10 %.

What that really tells us our rate of debt

Today, a first mortgage on the smallest condo will increase the debt ratio of an individual from 0% to over 250 %. This debt is supported on an asset, the condo, which will eventually be debt free. If we wanted to reduce our debt ratio, it would be giving up to buy her home.

The least indebted live to rent. The data show that Quebecers have a debt ratio lower than the canadian average. This is not because we manage our business best. It is that the rate of ownership is lower in Montreal than in other big cities of Canada and that real estate prices are lower here than in the rest of the country.

Ironically, this reveals that our debt ratio is lower, it is that we are probably less rich than elsewhere.

The good and the bad debts

I’m not saying that there isn’t anything to be cautious. A high debt level in a context of low interest rates poses a risk : that of being taken to the throat following an increase in accelerated rate. The scenario is unlikely. Then, let us not wield the same scarecrow. The major part of debts are necessary, they are good.

How to distinguish a good from a bad debt ?

  • Good debt is generally accompanied by a low rate of interest, which disqualifies all forms of consumer credit.
  • A good debt is concentrated not too much of its budget. As long as we can cope with the monthly payments without compromising the essential and to retain a margin of manoeuvre, there is no problem.
  • A debt incurred in order to enhance his skills and increase his earnings is excellent ; a debt to buy a consumer good that we would not have the means otherwise to offer is to avoid.
  • The best debt is tax deductible : one thinks in particular of the loans necessary to purchase an income property, sometimes also to invest prudently in equities.
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