The growing reliance of consumers on a variety of new credit products does not necessarily mean households are being lured by low interest rates into borrowing too much money, RBC economists say in a new paper. Instead, they suggest, the use of these products is a healthy innovation that reflects a change in the classic patterns of wealth management.

The RBC economists argue that, “a growing reliance on lines of credit, interest-only credit products, zero interest deferred principal loans, and hybrid flexible financing options is often misread as a sign that a cross-section of households are grossly mismanaging their finances, with speculative behaviour being driven by a low interest rate environment.”

“Instead, while there are potential pitfalls associated with such financing options, their introduction and adoption are more appropriately interpreted as a healthy reaction to three key developments affecting the management of household finances that open up more room for financial innovation while shifting the composition of risks,” it suggests.

The three developments are: an overall decline in inflation expectations that changes how people borrow by extending their planning horizons; increased innovation by the financial sector; and fundamental changes in the nature of the workforce that require more payment flexibility.

“Because of these developments, households are only now seeing the emergence of the kind of financing flexibility that has long been available to corporations and governments,” the paper says. “For example, they are using interest-only lines of credit that are very similar in nature to a plain-vanilla corporate coupon bond. A 0% consumer loan with deferred principal repayment is like a sovereign strip bond. A 0% car loan with amortized principal repayment is like a coupon-only corporate bond stripped of principal repayment.”

“Households are increasingly matching their financing needs with opportunities as they arise, taking advantage of a growing array of financing options to smooth income and consumption over their entire lifetimes,” RBC says, adding that the conclusion that flows from that “is that overall borrowing patterns are not excessive.” It notes the annual pace of household debt growth today is significantly lower than it was in the 1970s and 1980s.

“While there will always be cyclical variations that will cause some shifting in and out of floating- versus fixed-rate products, we’re probably still in the early stages of a long-lived preference shift toward credit lines, even if rates go up more than expected,” the paper predicts.

It notes there are important implications of this shift: there is room for more innovation in serving household borrowing and liquidity management needs; and, a proper understanding of what is driving household finances shifts the focus towards prepayment risk and away from credit quality.

However, it adds, there’s also “a greater need for individual prudence to be guided by sound advice from financial institutions. While households may be managing their finances more like corporations today, financial institutions must play the kind of role in guiding this change that is akin to the competent independent CFO of a small business in motivating sound choices.”

Finally, the classic wealth management model based on “accumulators, wealth preservers and decumulators” may be in the process of changing. The paper suggests this may help explain why predictions based upon demographic theories for spending, borrowing, and saving behaviour over the past decade have been so wrong.

“Instead of a gradual run-up in wealth to peak levels prior to retirement in a classic model that has wealth accumulators giving way to wealth preservers and decumulators, the shifting of future earning power to the present through debt markets and postponement of liabilities may well mean that the pace of wealth accumulation is faster sooner in life and slower later on. This smoothing of wealth over one’s lifetime also echoes modern business models based on companies with infinite lives; instead of waiting for retirement to draw on wealth, such decisions can be made regardless of age.”