The growing debt load

Here are some worrisome numbers that just came out. CIBC says that a poll conducted on its behalf by Harris/Decima Research revealed that 59 per cent of retired Canadians are carrying debt. Moreover, only 27 per cent of them are taking aggressive action to reduce their debt load.

The poll results confirm a trend that has been increasingly apparent for some time — more people are electing to go into retirement while they are still in debt, thereby setting themselves up for potential financial problems down the road.

Last year, a poll of higher-income Canadians commissioned by RBC found that 44 per cent of retirees surveyed had some form of debt. The most common types were mortgage loans, personal lines of credit, and consumer debt such as credit cards.

If both surveys are accurate, that trend is accelerating at a surprising rate.

The obvious question is why? One possible answer is in demographics. The people retiring today are primarily baby boomers. They represent the greatest consumer generation in the history of the world. They are also the generation that put credit cards in every purse and wallet and figured out how to use lines of credit to tap into home equity. If they wanted something and didn’t have the cash to pay for it, they simply used credit. That’s how they sustained a lifestyle that previous generations could only dream of.

Old habits die hard. The baby boomers may be starting to retire but many of them haven’t been able to adjust to a different way of handling money. They coped with debt before and they figure they can continue to do so.

Many of them are in for a shock. With interest rates so low, the cost of carrying debt right now is minimal. But at some point, rates will rise again. It probably won’t be for a few years, perhaps 2015, but it will happen. Bank of Canada Governor Mark Carney would like to move sooner rather than later but he is hamstrung by a limp world economy and concerns that higher rates would push up the value of the loonie.

When the inevitable does happen, the cost of carrying a loan will move up faster than most people realize. For example, a home equity line of credit typically carries an interest rate of prime plus a half point. Right now, prime is 3 per cent. Over the past decade, the average prime rate in Canada was 4.25 per cent. If it should return to that level, it would mean a 36 per cent increase in the interest cost on a line of credit. If it went higher, say to 6.25 per cent where it was in the fall of 2007, the cost of carrying a loan would almost double.

Where would people living on a fixed income find that money? Most of them would have to make lifestyle-changing decisions — not easy for retirees in their 60s and 70s. That could involve anything from cutting back on consumer spending, to selling the family home, to declaring bankruptcy. (Another study published by CIBC earlier this year found that more people over 50 are going the bankruptcy route.)

What can be done? For starters, people who have not yet retired should consider working a few more years to pay off outstanding debt. The CIBC survey found that, on average, Canadians expect to retire at 63. The hard reality is that’s too soon if you are carrying a lot of debt.

Those who are already retired should make a special effort to reduce the loan principal while interest rates are still low. Once they start to rise, it will be much more difficult because a higher percentage of income will have to be allocated to interest costs. Start with the highest interest debt (usually credit cards).

This is not something to take lightly. We could be looking at some serious social consequences down the road if this pattern continues. The baby boomers need to realize that they can’t keep using credit to pay for their lifestyle. There will inevitably be a reckoning, and it won’t be pretty.

Photo © Ricardo Reitmeyer

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