Debt Trends From StatsCan

Canadian-Mortgage-DebtCanadians’ debt levels have made headlines repeatedly over the past few years. People are engrossed with how big our debt burden has grown, and what it means to the economy at large.

On Thursday, Statistics Canada published a new report on how debt is affecting Canadian families. It contains loads of data and below are some of its mortgage-related findings:

  • In the last few decades, StatsCan says the general trend has been for “average household debt to move in the opposite direction” of interest rates. In other words, as rates fell, debt rose.
  • Between 1984 and 2009, “real average household debt for Canadians more than doubled from $46,000 to $110,000, with the main contributor to this increase being mortgage debt.”

Growth-in-Household-Debt

(Click chart to enlarge)

  • In 1990, “total personal and unincorporated business debt was equivalent to 93% of after-tax income. By 2009, total debt was equivalent to 148% of income.”
  • Research by TD Economics (cited in the report) suggests that “if interest rates rise by three percentage points, the debt-to-income ratio needs to fall to between 125% and 130% for interest payments on the debt to remain the same.”
  • StatsCan says the Bank of Canada considers households to be “at greater financial risk if their total debt payments are equivalent to 40% or more of their income.” By that measure, StatsCan estimates that “4.2% of all Canadian households had a high annual debt load.” (4.2% is a lot lower than some debt commentators might expect.)
  • While debt-to-income was climbing parabolically, the debt-to-asset ratio was relatively constant between 1990 and 2007. Then, from 2007 and 2008 debt-to-assets jumped by 2 percentage points to 19.6%, the highest level in 35 years.

Being interested observers of the housing market, we’re naturally inclined to wonder how rising debt levels will affect home prices. Interestingly, while debt-to-income is at all-time highs, mortgage affordability (which has a major influence on home demand) hasn’t strayed far from its long-term average.

Mortgage-Affordability

The question is, what happens to affordability when rates climb further.

Other things being equal, for every 1% that mortgage rates increase, households with an average income and high-ratio mortgage can afford roughly 9% less house.

Unless incomes rise significantly (few are betting on that), a rate-driven deterioration in affordability could curb home prices materially…and much more than any growth in non-housing debt.

 


 

Chart sources: StatsCan and RBC

 


 

Robert McLister, CMT

  1. Other things being equal, for every 1% that mortgage rates increase, households with an average income and high-ratio mortgage can afford roughly 9% less house.
    I always find this line of analysis odd, for it assumes that sellers are price setters and buyers are price takers, or, alternatively, that cash buyers are the tent poles supporting valuations regardless of rising rates.
    In markets where the winning buyer is typically low DP and high DTI, he isn’t going to get less house, the vendor is going to get less money.

  2. Rob, excellent analysis as always. I also think it is courageous. There are few in the mortgage and real estate industries I think that are prepared to report or even discuss the potential that we are headed into some headwinds in the Canadian housing market. I of course understand why, and I am not even sure if everyone in those industries did start understanding what the data is telling us, started reporting it, as this may lead to an unhealthy mass psychology problem. After all I am certain there is nothing more emotional than buying real estate. I for one continue to think and prepare for what I can do IF we have a slow melt in the market, instead of keep trying to convince myself that it “is different here”. If it does not happen then I am no worse off I think.

  3. Hi there Ralph,
    It’s not really as odd as it may appear. “Less house” is just another way of saying “a lower mortgage/purchase price.” Remember, the commentary here applies to home prices and not necessarily the size or quality of house.
    The 1%/9% relationship is merely a rough rule of thumb that, on it’s own, is a self-evident truth. In other words, it is factual that high-ratio buyers can generally afford a smaller mortgage (and in turn a lower purchase price) if rates increase X%.
    That says nothing about cash buyers supporting prices. The argument here is actually the exact opposite–that prices won’t be “supported” (by affordability) when rates increase.
    As we all know, the market sets prices and not buyers and sellers in isolation. Yet, when you take purchasing power away, that will certainly have an effect on demand at the margin. This effect could always potentially be offset by income growth, immigration, etc. but affordability is still a vital factor.
    Cheers…
    Rob

  4. Hey Greg, Many thanks for the post. We certainly can’t predict home prices and they could always continue higher a lot longer than any of us expect. Yet, at some point the market is due for a breather.
    In turn, it can’t hurt to preconsider the potential effect on borrower equity, our business models in the industry, etc.
    It’s always a little disconcerting to hear certain folks so assured that prices will indefinitely continue their 4-7+% annual price gains (as has been the case throughout the 90’s and 2000’s). When rates revert to the mean, that and the cutback on extended amortizations will put that thesis to the test. In that case, a long-term time horizon is mandatory, especially as a high-ratio buyer.

  5. Sorry to be “that guy” but the first chart does not enlarge when clicked as promised (at least in Safari, Chrome, and Firefox). Great article as always, though. Thank you.

  6. RBC chart is strange.
    You are saying about 4-7% house price increase/year. Is the average salary in Canada increasing at the same rate? Most probably not. Otherwise the annual inflation would be in the range of 4-5% and not 2%.

  7. I think you’re forgetting that interest rates have been falling for years. Falling rates have kept mortgage affordability within reach despite home prices rising.

  8. I have no doubt there is a tipping point whereby rising interest rates will negatively affect home prices. The great unknown appears to be nailing down exactly where that elusive tipping point resides.
    Case in point is the most recent set of interest rate hikes (which were halted last September) by the BoC, which added 75 basis points to the overnight rate.
    Regardless, the real estate market continues to climb. The market appears to have been able to absorb the hit without losing stride.
    Perhaps carefully measured and gradual interest rate hikes are the way to go, followed by a pause to allow rising incomes to mitigate (not necessarily offset)the higher monthly costs associated with increased mortgage payments.
    Significant corrections in the real estate market are always associated with recessions and outside of perhaps Garth Turner, I don’t believe anyone wants to go there anytime soon.

  9. The BOC will probably try to raise slowly but inflation, and not home prices, will ultimately dictate its course.
    I have to wonder whether the next price correction will require a recession. Rates have never been so low, prices never so high, and people never so indebted. I must dare to ask, “Could it be different this time?”

  10. Household debt is rising because? Is there anyone out there who can seriously answer this question?
    Our household debt is the highest it’s ever been. And we don’t even own a house.
    Lots of things are going down in price. But the most important stuff we live by is always going up.
    How is it possible that my family lived for 40 years with no debt whatsoever and are now suddenly saddled with crippling amounts of debt for regular living expenses like heating oil, insurance, etc.? And all the dinging-to-death charges of telecoms, internet providers and insurance companies?
    We’re not doing anything differently, and suddenly two salaries for our family are still not enough. What exactly is happening?

  11. The market determines the house price based on mortgage payment. So low interest rate environment is bad for buying a house. In the 1980s with 20% interest rate, what was the house price to income ratio?
    But if one can afford to buy a house it doesn’t matter. e.g with saving and relative stable job and ability to pay off the mortgage in around 10 years if try the best to pay it off.

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