Growing debt could spark tougher financial policies

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Canadian consumer debt has shot up to unprecedented levels in recent years. Average Canadians racked up debts 150 percent greater than their income on credit cards, auto and home loans and other lines of credit while national consumer debt levels climbed to $1.6 trillion in the last quarter of 2011, according to a Reuters report. But financial experts and regulators say it's not time to panic – yet.

Personal debt is a growing concern across the country and raises questions about the sustainability of household finances, according to James MacGee, author of a new C. D. Howe Institute report that looks at Canadian debt. There are several trends that leave Canadians open to an American-style recession, and they merit a careful look, he says.

"While the recent U.S. experience highlights the risks of overextended consumers, more prudent lending standards in Canada suggest that, under likely scenarios, consumer debt levels should remain manageable," according to MacGee's report. "Nonetheless, these high levels of debt leave Canadian consumers vulnerable to large economic shocks – notably a sharp rise in interest rates or an economic downturn."

For homeowners, perhaps the simplest way to protect against rising interest is to negotiate for fixed mortgage rates on home loans. That way, monthly payments will remain fairly consistent and budgeting to reduce debt will be easier. Up to 45 percent of household interest payments are made toward personal debts, many of which carry variable interest rates, MacGee points out. The more consumers can reduce the likelihood of a significant hike in monthly expenses, the more manageable their debts will be.

Another important step that can be taken to mitigate risk across Canada is to improve citizens' financial literacy and simplify the language of many debt and lending related forms. More borrowing options have arisen in recent years, and with them the number of consent forms and information packets designed to help consumers make informed decisions. But literacy can only solve part of the problem.

"Many Canadians lack the numeracy and literacy skills required to readily evaluate and compare financial products," the report suggests. "In addition, some financial instruments can be difficult even for sophisticated borrowers to evaluate fully. This means that, while essential, financial literacy is only one part of the solution to improved consumer choices."

Financial regulators, meanwhile, feel stuck in a quandary over how to solve the debt crisis. In a discussion with The Canadian Press, Bank of Canada Governor Mark Carney suggested financial policies could be used under extraordinary circumstances to staunch the flow of credit and reign in consumer debt. And if Canadians can't get their houses in order soon, Carney said he is prepared to implement those policies.

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