Indebtedness and the Household Financial Health: An Examination of the Canadian Debt Service Ratio Distribution

The household debt-to-disposable income ratio in Canada increased from 110 per cent in 1999 to 127 per cent in 2007. This increase has raised questions about the ability of households to service their increased debt if faced with a negative economic or socio-economic shock. The debt service ratio (DSR) measures the proportion of disposable income that households must devote to servicing their debt obligations. The aggregate DSR for Canada, as reported in the Bank of Canada's Financial System Review, has drifted up recently but remained below its historical average in 2007Q4. This would suggest that households' debt burden has remained broadly manageable. However, the aggregate DSR could mask potential vulnerabilities for the most heavily indebted households. The main contribution of this paper is that it examines the distribution of debt service burden amongst Canadian households using micro-data. This work shows that the density of households in the vulnerable tail of the DSR distribution has actually decreased somewhat since 1999, especially for lower-income households. Overall, our micro data analysis support inferences based on the aggregate data that, despite the increase in the debt-to-income ratio since the late 1990s, households remain well positioned to manage their increased debt levels. The paper also compares the DSR distributions for Canada and the U.S. The cross-country comparison suggests that, in 2004, the household sector in Canada seemed to be in a better financial position than U.S. households.