No doubt about it, recent headlines about household debt, rising mortgage interest rates and high house prices in Toronto and Vancouver are scary.
The Bank of Canada says that about 720,000 households are vulnerable to financial collapse because they have a debt-to-gross-income ratio of more than 350 per cent. It says these households tend to be younger, lower- to middle-income families who live in B.C. and Ontario, where house prices keep rising, or Alberta, where falling oil prices have hit the economy hard. Recently the Bank of Canada tightened the down payment requirements for insured mortgages in an effort to keep homebuyers from taking on too much debt.
"While debt management should be a concern for many Canadian families, this doesn't mean they all have a debt problem," says a report by the BMO Wealth Institute. It says the numbers are skewed by the small percentage of households with a lot of debt. "This means that there are many households that have debt-to-income ratios that are much lower than the national average. Furthermore, it is encouraging to note that the percentage of households that are debt-free has increased over the last three years."
The rate of mortgage arrears in Canada is very low (0.27 per cent as of August 2015) and falling.
In a report for Mortgage Professionals Canada, economist Will Dunning says that low mortgage interest rates are allowing homeowners to pay their loans off faster.
"Canadians are highly motivated to repay their mortgages as quickly as possible," says Dunning. Each year, more than a third of mortgage holders take actions to shorten their amortization periods, such as making lump sum payments, increasing their regular payments or increasing the frequency of payments.
"As interest rates have fallen, the share of the payment that goes to principal has increased sharply," he says. "At today's rates, and assuming a 25-year amortization period, 50 per cent of the first payment is principal repayment. A decade ago the share would have been 31 per cent.
"Most mortgage borrowers understand that the principal part of their payment, while a cost, goes to their bottom line and improves their financial situation. The ‘net cost' of homeownership (excluding principal repayment) is now very low in historic terms (in relation to incomes, and indeed relative to the cost of renting equivalent accommodations). This goes a long way to explaining the continued strength of housing activity in Canada."
But what happens when the historically low interest rate begins to rise?
"A survey of current forecasts from the major banks indicates that the average expectation is for bond yields to rise by 1.5 points by the end of 2017," says Dunning. "Mortgage rates may be expected to rise by similar amounts. Yet, during the past half-decade, there has been a consistent expectation of a future rise of similar magnitudes. So far those expectations have proven wrong."
However, Dunning says if interest rates were to rise to 3.5 per cent (a three-quarter point increase in typical rates for a five-year fixed-rate mortgage, and a one point hike for variable rates), it would mean about 400,000 households that took out a mortgage from 2011 to 2015 would see interest costs rise by more than $100 a month.
Of this group, about three-quarters have made voluntary extra payments in the past "and therefore, they have some flexibility to adjust their future payment levels" by adjusting the amount of principal they pay, says Dunning. "Most of them borrowed less than they were ‘qualified' for, and at the outset had budgetary room to accommodate future cost increases.
To varying degrees, most will have experienced income growth since they purchased the home."
He says that many Canadians are also renting out a portion of their homes to help with mortgage payments and this could also be an option.
"While we can't say for certain what the impacts will be for future renewals at higher interest rates, the impacts are likely to be much less dire than is often suggested," says Dunning. "Commentary and studies on risks related to future mortgage renewals generally do not consider the four mitigating factors discussed above and most likely overstate the risks."
The Mortgage Professionals Canada report says on average, home equity in Canada is equivalent to 71 per cent of the value of homes. "In other words, for every $1,000 in house value in Canada, there is about $290 of debt and $760 of homeowner equity." It says more than 85 per cent of homeowners have 25 per cent or more equity in their homes.
Dunning says the association also surveyed to what extent people see their homes as investments.
"If housing is viewed too strongly as an investment and expectations about price growth cause activity to depart significantly from what it should be (based on economic fundamentals), then there would be risk of a bubble," he says. The association found that 73 per cent of respondents think of their homes as "a place to live", while 27 per cent think of it "as an investment."
Dunning says, "If there was a bubble psychology, we would expect to see a strong relationship between house price growth and resale market activity. This research finds that house price growth has only a very weak effect on activity: housing market activity in Canada is very much determined by economic fundamentals rather than by ‘speculative attitudes' (or, alternatively, by fear about ‘missing out').
"All of this considered, there is a strong case to be made that Canadians have healthy and productive attitudes about the investment aspect of homeownership," he says.