Arrears in Context

Arrears-MortgageThe Vanier Institute issued a report today on Canadians’ finances. This line made a lot of headlines:

The number of households which have fallen behind in their mortgage payments by three or more months climbed to 17,400 in the fall of 2010, up nearly 50% since the recession began.

50% is certainly attention-getting, but that number needs perspective.

In and of itself, an increase in arrears generally isn’t alarming. Arrears have wide fluctuations over time and are largely random on a month-to-month basis. Moreover, arrears always increase in recessions (as people lose their jobs). That is a completely natural phenomenon in our business cycle.

In the recession just past (Q4 2008 to Q2 2009), homeowners weathered the storm far better than in prior recessions. The 51% increase in arrears was considerably less than in the April 1990-April 1992 recession. In that downturn, arrears soared over 260%!

As it stands, the latest data shows that arrears have actually fallen in the last year.

More importantly, the numbers in question are tiny on an absolute basis (a 5,927 increase in people 90+ days behind on their mortgage…out of more than 4,000,000 mortgages).

The-Vanier-InstituteAs a side note, the October 2010 arrears data used by Vanier isn’t new. It’s been out for a while and reported elsewhere. Here’s the source data (PDF) from the CBA.

For the most part, arrears are just a normal reality of the mortgage market and our current 0.44% rate should generate no concern.

On the other hand, if arrears were to break 1.02% (the modern day high from 1983), or even 0.65% (the 90-92 recession high), then that would be worthy of headlines.

Sidebar: Vanier’s report has a few other mortgage-related data points. We won’t cover those as they’ve been reported widely in the media. Here’s more from CTV.

Rob McLister, CMT

  1. Thanks for the links! =)
    With some mortgage rules changing next month, we can expect to see more attention from the media about household debt problems, the viability of CMHC and whether it can withstand a surge in defaults, etc. The mortgage market in Canada is safe because of responsible underwriting and proven risk control measures.

  2. Responsible underwriting and proven risk control measures…?
    This one’s easy to debunk, if RE corrects as it should and drags the ‘economic recovery’ with it(anyone investor worth his weight who understands asset driven investments knows that the current RE ride is not sustainable), the question that should be on everybody’s lips is: If I lose my job and can’t replace it…”how am I gonna pay that mammoth mortgage?” McDonalds fry cook job does not equate to that engineering job lost outsourced to India.
    But that won’t happen because “we’re different”.

  3. Apparently it’s not so easy to debunk because you haven’t debunked anything.
    It sounds like you’re saying that millions of Canadians will soon be cooking french fries at McDonalds. That’s one heck of an argument. Thanks for that.

  4. Prediction: within 3-5 years the record will be broken.
    (more than 1.02% of mortgages in arrears)
    The recent growth in HELOCs is a major indicator that people are living beyond their means, and the new 85% LTV refinancing rule will make it that much harder for people to get out from under their debts.

  5. I agree with Stats. We have a spike in arrears now with the lowest interest rates in history? Amazing. What will happen when rates rise? Unfortunately, it will likely get ugly as Stats predicts. 1% doesn’t seem like a lot, but in most provinces you just can’t walk away from your mortgage, which means, yes, your mortgage will get paid as rates increase, but you will have less and less purchasing power and that is never good for the broader economy.

  6. Rae:
    What spike in arrears? Arrears have fallen in the last year. Prior to that arrears were higher only because of the recession. Now the economy is recovering (knock on wood).
    That 1.02% arrears rate in 1983 was caused by 20% interest rates and a recession much worse than 08-09 (in terms of GDP and job losses).
    In my opinion there is no way we will break 1% arrears again without another major economic shock.

  7. Yes, the 1980’s had 20% interest rates, but people actually had down-payments back then! There was none of the 5% down / 35-yr / cash-back trickery that goes on today.
    To put the differences in perspective, I would argue that a scenario with 20%+ mortgage rates today would wipe out probably 50% or more of all mortgage holders… a 1.02% default rate in 1982 seems like a minor miracle under those conditions.

  8. Stats and Rae: I must disagree with both of you. A 0.44% arrears rate in December 2010 is not a spike, it’s just normal growth over .42% the month before and flat for 18 months bouncing between .42% and .45%.
    This reflects the same cycle we saw twenty years ago – that continued for ten years during the 1990’s – after coming out of a recession. The arrears rate never popped above .65% during this ten year period.
    I will bet anyone $1.02 that we don’t break this record in the next 5 years….I’ll even give odds because I don’t see how we can come close. The financial triggers are not there, and as Rae points out, mortgages are full recourse in this country, so strategic default is not an option.
    As for Stats point on the 85% rule, that is so true! This rule is government stupidity at its finest because it puts a lot of unnecessary pressure on young homeowners. But I still don’t think it equates to doubling the arrears rate. S.

  9. Just to put this all in perspective… what would you guess the monthly payment would be for the “average” Canadian house if rates went to 20% again?
    Well, a $400k mortgage @ 20% with a 25-yr amortization is $6500/month!!!
    Even a $200k mortgage would be well beyond the affordable range for most Canadians.
    So, it’s clear to me that we’re in a completely different economic reality vs. the 1980’s.
    Again – that 1.02% arrears number seems incredibly low, considering the circumstances. Any comparisons between 2011 and 1983 need to factor in other key data such as the size of the mortgages and LTV.

  10. Wage growth was also much higher in the 1980s, so it’s absolutely a different economic reality.
    By the way, your example for the “average” Canadian house is ridiculous. According to CREA, the national average resale price in January 2011 was $328,728, nowhere close to $400,000.
    Then add in the fact that, according to CMHC’s 2010 Canadian Housing Observer, only 60% of homeowners have a mortage, and that 80% of mortgagers have at least 20% in equity, and I’m sure you’ll agree that the 400K example is way too high.

  11. ok, let’s look at someone with 20% equity in a $328k house… maybe we can assume that their income is the “average” for Canada: about $74,600.
    Using these values, the mortgage is 80% of $328k, or $262,400.
    @ 20% / 25-yr, that is $4238/month.
    That $74,600/yr average income is $6216/month.
    So, in this scenario, the *average* person’s income is 68% gone before they even pay for any food, gas, utilities, or property taxes. Again – this is the *average*, meaning many are worse off.
    That “average” scenario would still produce some huge percentage (say 25%-30%?) in arrears vs. the 1% that was reached in 1983… again, it is shocking to me that the peak was only 1%!!!
    Side note: the 40% of homeowners without mortgages will obviously not be the ones in arrears, so I don’t see how that is relevant?

  12. You can’t apply 20% rates to today’s economic environment. With a mature economy and the Bank of Canada’s inflation targeting we’ll never see anything close to 20% mortgage rates again.
    25% arrears is also crazy talk. Even after one of the worst housing crashes in the industrialized world, total 90-day delinquencies never exceeded 5.02% in the U.S., a peak that occurred during the first quarter of 2010.

  13. Yes – that was my original point: the statement that “it’s unlikely we could break 1.02%, because we wouldn’t get 20% interest rates” is not considering the fact that mortgage-holders today are WAY more leveraged than back then.
    I believe that the 1.02% record could be broken in the next few years – precisely because it isn’t 1983, and it wouldn’t take anything even close to 20% rates to get above 1.02% in arrears today.

  14. My broader point is that you have to make reasonable assumptions in constructing scenarios. As you point out, a massive spike in interest rates would be disastrous for many people, but interest rates suddenly shooting up to 20% is about as likely as my Oilers winning the Cup this year. Even 10% would be highly improbable.
    According to the Bank of Canada, the prime rate has maxed out at 7.25% over the past 10 years (at the very start of the reference period). It’s averaged 4.46%. The Bank explicitly targets inflation to prevent such a scenario from occuring. The economy would have to get ridiculously, ridiculously white hot over a long period for interest rates to shoot up that high. It simply isn’t going to happen.
    Having said that, you know when people would be *really* screwed? If interest rates jumped up to 80%. God help us then.

  15. Most Canadians have fixed-rate mortgages (not variable), and those are driven by the bond market… which is not controlled by the BOC.
    The record debts take on between 2007-2011 will be up for renewal between 2012-2016, which is why I believe the record will be broken during that time.

  16. Just so I’m clear, you’re maintaining that there’s no relationship between the bond market and the actions of the Bank of Canada, such as the setting of short-term interest rates?

  17. How do you get from this
    “Most Canadians have fixed-rate mortgages (not variable), and those are driven by the bond market… which is not controlled by the BOC.”
    …to this…?
    “Just so I’m clear, you’re maintaining that there’s no relationship between the bond market and the actions of the Bank of Canada, such as the setting of short-term interest rates?”

  18. Nice to see you back dave. I thought all the slings and arrows you suffered had caused you to move along?
    He seems to be implying that the Bank of Canada doesn’t have influence on the bond market, and within the context of the past few posts, can be ignored vis a vis fixed rates. In any case, my response was phrased as a question (hence the ? following the sentence). Perhaps he means that the BoC has only a little bit of influence. Not sure – hence the question mark.

  19. @Stats. There are many fallacies in your logic.
    Mortgage affordability today (carrying costs vs. income) is as good as it was in the early 80’s.
    More importantly, far fewer people are maxed out today than you might think. I recall numbers from CIBC stating that only 4% of households have less than 20% equity and a total debt ratio of more than 40%. Most people have plenty of ability to weather rate increases.
    Speaking of which, hypothesizing about the return of 20% interest rates is complete silliness. I almost never say never but 20% prime will never ever return to this country. If fact, I bet we’ll never see anywhere near 10% in our lifetimes. The economy can’t support it and inflation doesn’t justify it.

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