Editorials have been overflowing lately with speculation on how rising rates may lead to a surge in mortgage defaults.
CIBC economist, Benjamin Tal, says history doesn’t support that premise.
In a report yesterday he wrote:
“Mortgage arrears rates are highly correlated with the unemployment rate.”
Mortgage arrears have “little or no correlation with changes in interest rates.”
(Perhaps this is why default rates peaked at only ~1% in 1982-83, despite 21%+ mortgage rates in 1981.)
“Interest rates rise when the economy recovers…the benefits to employment and incomes of an improving economy easily offset the sting of higher interest rates on debt service costs.”
The Bank of Canada (BoC) estimates that 5.9% of Canadian households are “vulnerable to rising interest rates, since their debt service ratio (DSR) exceeds 40%.” CIBC estimates the number at 4.0% because many of these homeowners still have significant home equity.
Of the five million Canadian households with a mortgage, only 350,000 or so have a mortgage with a loan-to-value exceeding 80% and a debt service ratio greater than 40%.
The BoC forecasts that the share of households with a 40%+ DSR would climb to 8.5% by 2012 if interest rates rise by 3%. (Assuming they're right, most would consider this increase manageable.)
Despite the “buffers” above, Tal says, “It is time for both borrowers and lenders to exercise prudence in continuing to build up household debt loads to the point where they are overly reliant on today’s low rates.”
To this we’d agree, and add: There is no better time in history to pay off debt instead of rack it up. Today’s 2.25% prime rate won’t last forever. Rates this low are affording people a once-in-a-lifetime opportunity to pay off large amounts of debt principal.
