The COVID-19 pandemic continues to bring financial instability with an increased debt-to-asset ratio. With mass job loss in Canada and decreased revenue for Canadian small businesses, families and individuals struggle to manage their finances during this unprecedented time.
It’s clear that more Canadians took on debt, but this isn’t always a sign of financial instability for everyone. While those who experienced job loss faced more strain on their finances, some Canadians took advantage of the pandemic’s arguably favourable effects (for some) on the housing market.
Household debt increased in 2020
Despite the increase in the debt-to-asset ratio, those with unaffected incomes, or those who experienced rapid recovery, took advantage of low mortgage interest rates and invested in real estate. The increased interest in real estate can also be explained by the increase in savings by some Canadians, as at-home restrictions limited day-to-day spending. Existing property owners were also encouraged by the pandemic to use their significant equity to make real estate movements.
Additionally, the quick recovery of the market unleashed what the Canadian Mortgage and Housing Corporation describes as pent-up demand for housing. The housing demand increased drastically after June 2020.
The increase in demand and activity in real estate resulted in an increasingly hot housing market. Real estate activity increased by a whopping 39.2%, and housing prices increased 17.7% from last year. the Canadian housing market. Sellers have realized the market is in their favour and acted quickly, as seen by the 15.7% increase of newly listed properties just in one month, from January to February 2021.
So, the hot housing market resulted in many Canadians taking on more debt; however, this kind of debt doesn’t demonstrate financial instability for those Canadians buying houses. If anything, they are doing even better despite the pandemic’s harsh effects on other groups. See what impacts your debt-to-asset ratio below.
Wages, Salaries and Disposable Income
Wage and salary effects varied greatly across different industries during the COVID-19 pandemic. While online retailers experienced record sales, other industries like the restaurant sector and oil and gas sectors experienced a significant decline. One might assume that disposable income would have decreased for the average household during the pandemic, but that’s only mainly true for middle to higher-class households.
Lower-income households actually experienced an increase in disposable income due to government subsidies and support, such as the COVID-19 Emergency Response Benefit(CERB), in the second quarter of the pandemic.
Debt-to-Income Ratio (DTI) narrows disposable income
The debt-to-income (DTI) ratio measures the amount of debt that a household carries compared to its disposable income. Disposable income refers to saving and spending money after taxes.
To calculate your DTI ratio, you add all of your debts together (credit cards, business loans, lines of credit, mortgages, etc.) and divide it by your yearly income before taxes.
For example, if you have:
- $100,000 left on your mortgage, $20,000 in student loans and $2,000 in credit card debt ($122,000 total); and
- A $100,000 salary;
Your DTI ratio is 122,000/100,000= 122%, or $1.22 of debt for every dollar of income.
Canada’s average household DTI ratio climbed to 175.4% at the start of the COVID-19 pandemic. This means that for every dollar of income a Canadian made, they had $1.75 in debt. Average Canadian DTI ratio increases are significant and demonstrate the harsh economic effects of the pandemic. This is especially true considering a 50% DTI ratio can be dangerous, while a 36% DTI ratio is decent.
The effect of higher DTI’s on credit scores DTI and Obtaining Credit
Although DTI ratios do not necessarily affect your credit score, lenders still look at it when considering your loan application. Since having a high DTI ratio means you have more debt compared to your income, lenders often assume that those with lower DTI ratios are more likely to make their loan payments.
For a strong loan application, you should consider lowering your DTI ratio. Try to avoid scenarios that might increase your DTI ratio before applying for a loan, including:
- Overspending and poor budgeting
- Investing in real estate (getting a mortgage)
- Job changes and periods of unemployment distress
Debt and how to manage it Final Thoughts
The COVID-19 pandemic destroyed some jobs and industries but increased the wealth of some individuals. While the debt-to-asset ratio of middle and lower classes was disproportionately affected by job loss and wage freezes, Canadians of higher income brackets and homeowners experienced favourable scenarios for increased debt in the form of mortgages.
