What is the Debt-to-Income Ratio in Canada?

Jack Prenter, Founder of Dollarwise

The debt-to-income ratio in Canada has been on a downward trend since the end of 2021 but remains relatively high at 181.57%. This means that for every $1 of disposable income, Canadians owe $1.82 to creditors. 

However, does it actually mean that Canadians are having trouble repaying their debts and does mortgage debt play a role or is it something you shouldn’t worry about? The truth is there is a better way of looking at Canadians’ ability to repay their debts, called the ‘household debt service ratio’ (HDSR).

But before we get to that, we first need to analyze how the average household debt-to-income ratio has changed in Canada over the past few years. 

What is the average household debt-to-income ratio in Canada?

As of Q3 2023, the average debt-to-income ratio in Canada is 181.57%, less than in any quarter going back to Q3 2021. 

We can see some mild growth from Q1 2013 to Q4 2015 when there was a larger increase spanning from Q4 2015 to Q2 2016. Following Q2 2016, both the average debt-to-income and credit + mortgage liabilities-to-income (household service debt) ratios stagnated and didn’t experience much change. 

Due to the Covid-19 pandemic in Q1 2020, both ratios took a ~20% average plunge, but they quickly bounced back and started slowly increasing/stabilizing from Q3 2020 to today. The 20% plunge was primarily due to people choosing not to go into more debt due to the economic uncertainty surrounding the pandemic. 

While the debt-to-income ratio in Canada isn’t at its highest in Q3 2023, it’s still pretty close to the record high of 185.40% (for reference, today’s ratio is 181.57%, a 3.83% difference)

Does the Canadian debt ratio impact you?

The media likes to overblow the potential impact of the Canadian debt-to-income ratio. Often, they like to preface their reports by saying that Canadians are in a lot of debt. 

However, this isn’t exactly true for a couple of reasons. First, the debt-to-income ratio in Canada has largely been the same for the past 7 or so years with just a few slight fluctuations due to some global events (Covid-19 pandemic, etc.). 

Secondly, the debt-to-income ratio is not the best metric to show how much you owe; all it shows is how much all Canadians owe compared to how much income everyone has at their disposal. It’s still an important metric to consider but on an individual level, it’s best to look at your household debt service ratio. 

The household debt service ratio determines your ability to pay off your debts. Having a ratio of, for example, 200% doesn’t necessarily mean you’re too much in debt or spending well above your financial capabilities. 

Mortgage debt & interest rates vs. consumer debt

We know that consumer debt has been on the uptick for decades, with current stability being an outlier. But what exactly contributed to this increase? Two ‘players’ – mortgage debt and interest rates. 

The principal residence mortgage rate was $91,900 in 1999. In 2016, it equaled $180,000 – almost double 1999’s rate. This mortgage rate increase and the combination of low-interest rates and higher housing prices are major contributors to the consistent growth of the debt-to-income rate in Canada. 

EstimateQ3 2022Q4 2022Q1 2023Q2 2023Q3 2023
Mortgage Debt (x 1,000,000)122,492130,580137,692142,044145,512
Non-Mortgage Debt (x 1,000,000)110,420113,984116,904119,172121,504
Mortgage Interest Paid (x 1,000,000)65,62477,18887,38092,52895,872
Non-Mortgage Interest Paid (x 1,000,000)51,23656,06061,44864,14466,536
Of Which Mortgage Debt (x 1,000,000)42,69646,48851,12853,40855,416

Source: Statistics Canada

At the moment, the debt-to-income ratio shouldn’t be cause for concern as there is stability, but if the housing market crashes or interest rates begin rising quickly, there will be financial uncertainty and dramatic changes to the overall economic status of Canadians. 

How do you define the debt-to-income ratio?

Let’s delve deeper into the debt-to-income ratio definition. In essence, we calculated the 181.57% at the beginning of this article by dividing the total amount of debt that Canadians owe by their overall disposable income for 12 months. 

  • (Total Debt / Income After Tax) x 100 = Debt-to-Income Ratio

While useful for analyzing the entire country’s capability to pay off their debt, it isn’t particularly useful for most Canadians and lenders since it doesn’t include an individual’s debt-payoff ability. 

For the most part, this number won’t be used to determine how capable you are of paying your debt. One example would be a person who just bought their first home, with a large mortgage following suit.

Just because they now have a new mortgage doesn’t mean they aren’t capable of paying off their debt (as the debt-to-income ratio would have you believe).

That is precisely why lenders prefer using the household debt service ratio as it gives them a much more accurate representation of an individual’s credit status. 

Using the household debt service ratio for more accurate analysis

The Household Debt Service Ratio is a more effective metric for assessing financial health in Canada, particularly regarding credit card debts. This ratio compares gross income to actual debt payments, offering a realistic view of an individual’s financial commitments. 

An ideal HDSR is below 43%, the standard used by lenders. Recent trends show a slight decrease in the average Canadian HDSR, indicating that most can comfortably manage their debt obligations. 

This metric is crucial for Canadians of all financial backgrounds to understand their true financial capacity and manage credit card debts effectively.

Why is the household debt service ratio important to lenders

The Household Debt Service Ratio is preferred by lenders as it’s a much more accurate credit-health metric than the debt-to-income ratio.

A high HDSR suggests that a borrower might be overextended, potentially struggling to meet debt obligations after accounting for taxes, pension contributions, employment insurance, and essential living expenses. 

Lenders prefer this ratio to be under 50% to ensure there’s enough income for these expenses. Additionally, HDSR’s inclusion of gross income offers a comprehensive view of a borrower’s financial situation, aiding lenders in making informed lending decisions.

How to calculate your household debt ratio in Canada?

Simple – use this formula:

  • (Total Monthly Debt Payments / Gross Monthly Income) x 100 = Household Debt Ratio (HDSR)

You should also know which debt payments to include in your calculations so the resulting ratio is as accurate as can be. These are:

Here are a couple of example calculations to help you visualize this even further:

Example #1:

  • Monthly Household Income: $7,500
    • Car Loan Payment: $650
    • Mortgage (with taxes and insurance): $1,500
    • Minimum credit payment: $70
  • Total Monthly Debt: $2,220

In this example, the HDSR is ($2,220 / $7,500) x 100 = 29.6%. Any lender would be very happy to lend money after seeing this HDSR. But what happens when it’s above 50%?

Example #2:

  • Monthly Household Income: $4,500
    • Car Loan Payment: $700
    • Mortgage (with taxes and insurance): $1,500
    • Minimum Credit Payment: $50
    • Student Loan Payment: $400
  • Total Monthly Debt: $2,650

The HDSR here is 58.8% which can impact the outlook lenders have on this example’s spender. So what should you do to make your HDSR or debt-to-income ratios better?

How to make your debt-to-income ratio better?

1. Get a side gig

Boosting your income is key to improving your debt-to-income ratio. Consider options like freelancing or part-time work, which can provide additional earnings and help lower your overall debt burden.

Even $300/Month can go a long way in lowering the ratio. Let’s take example #2 from the above section and see how the additional income lowers the debt-to-income ratio.

  • Monthly Household Income (without the additional $300/mo): $4,500
  • Total Monthly Debt: $2,650
  • HDSR: 58.8%
  • Monthly Household Income (with the additional $300/mo): $4,800
  • Total Monthly Debt: $2,650
  • HDSR: 55.2%

That’s a 3.6% ratio decrease for just an additional $300 per month from a side gig. 

2. Get rid of your credit card debt

High-interest credit card debt significantly impacts your financial health. Focus on reducing or eliminating this debt, possibly by utilizing balance transfer offers from credit cards with lower interest rates to reduce payment burdens.

3. Consider your mortgage

If possible, explore refinancing options for your mortgage. Lower interest rates can reduce monthly payments and increase the portion of payments going toward the principal. However, be aware of potential penalties and new fees that can reduce the positive effect of refinancing your mortgage. 

4. Start budgeting

Creating and adhering to a budget is crucial for keeping your HDSR low. By tracking your expenses and identifying areas for savings, you can allocate more resources toward reducing your debt, thereby improving your debt-to-income ratio.

Keeping to the budget is especially important during the holiday season as most Canadians spend more on Christmas than they originally thought they would. 

Conclusion

On a country-wide level, the basic debt-to-income ratio in Canada can help with determining the overall financial capabilities and health of the entire nation. However, it’s not a good metric when it comes to the individual. 

The Household Debt Service Ratio accurately describes an individual’s spending power contrasted with their overall debt. This metric allows lenders to better analyze their client’s ability to repay the borrowed money. 

The HDSR can be lowered through various means, including budgeting, mortgage refinancing, eliminating credit card debt, and generating additional income through side hustles or freelance jobs. 

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