Lender upselling has raised the stakes for Canadians addicted to debt: Don Pittis

While bank employees have been under pressure to encourage customers to borrow, Canadians have been all-too-willing dupes.

Rock-bottom rates that only seemed to be going one way — lower — have created a unique situation where both lenders and borrowers have begun acting like addicts.

And as rates begin to rise, the process of withdrawal from that borrowing binge is likely to have painful symptoms for the entire economy.

Driven to lend

But first, to make it very clear, aggressive lending has not just been limited to banks.

"Margins are very thin," says Martha Durdin, president and CEO of the Canadian Credit Union Association.

"Banks and financial institutions traditionally made their money on margins, to a large degree. And because of that, fees and other ways of making money are more important." 

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I spoke to the head of one credit union who said that, following a poll of its member-owners, they had eliminated fees altogether.

But when it comes to looking for borrowers, thin margins — the gap between the amount they pay out in interest and the amount they can charge for loans — affect credit unions as well as banks.

Durdin insists that because of the co-operative nature of credit unions, where the borrowers are also the owners, employees at her member institutions have not been as pushy as those at the big banks. They are not under the same kind of pressure to drive shareholder profits.

Margin squeeze

But the margin squeeze has affected financial institutions around the world. And it's been going on for a while.

The Financial Times noted in 2013 that big U.S. banks were set to report "the thinnest margins between the rates at which they borrow and lend since the 1950s," because profits had been squeezed by the Federal Reserve's ultra-low interest rates.

At that time, Wells Fargo — the bank subsequently fined for fraudulently collecting fees for unwanted accounts — warned that it could not find "safe and profitable avenues" to lend all the money it had on its books.

In such a climate, Canadians are ideal borrowers. Canadian consumer default rates are tiny especially when loans are secured by a fully or partially paid-off house.

That's why a visit to your bank or credit union for some other purpose often ends in a reminder of how much money you are eligible to borrow.

Willing borrowers

Financial companies have been more-than-willing lenders. But there are several reasons why Canadians have been such enthusiastic borrowers.

Last week, new figures showed that consumer lending now totals more than $2 trillion, a new record. As we reported last week, for every dollar of Canadians' disposable income, they owe almost $1.67.

From the point of view of Canadians, money has never been so cheap. But the rising cost of housing, especially in the country's biggest cities, has also drawn people into taking on more debt.

In the U.S., low rates were intended to help the country dig itself out of a post-2008 economic collapse. 

Following the real estate collapse, U.S. consumers who had had their fingers burned were slow to start bidding on houses again, despite low rates.

But in Canada it was a different story. 

The Bank of Canada also slashed interest rates, hoping businesses would borrow and invest. But Canadian real estate had held its value and the ultimate effect of low rates was to create a vicious circle of rising prices in Canadian homes.

Cheaper money made it possible for homeowners to carry a larger burden, sending prices higher. Rising prices forced borrowers who wanted to buy a home to borrow even more.

Yellen's latest warning

But increasingly, there are signs the cycle of falling interest rates is coming to an end. Last week U.S. central banker Janet Yellen raised rates again, the second time in three months. This time, when she promises more rate increases to come, people seem to believe her.

Meanwhile, banks in Toronto's overheated market warn of a bubble.

Already there are signs that the cost of consumer lending is on the rise. And small changes in rates make a big difference to consumers.

An RBC customer in Manitoba reports that the bank has just hiked the rate on his unsecured line of credit from 1.5 per cent above prime to 2.25 above. That 0.75 per cent increase will raise his borrowing costs by hundreds of dollars a year.

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In one way, rising rates will be good for the banks as the thin margin gets fatter.

But rising rates will not be good for Canadians who have become addicted to low-cost borrowing.

All the debt they've taken on will start to get more costly as they pay an increasing share of their income to lenders. Rising costs will make them reluctant take on new loans.

And as the borrowing begins to dry up, suddenly the Canadian economy could wake up with a powerful debt hangover.

Follow Don on Twitter @don_pittis

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