The BoC on Debt

Bank-of-Canada-Benchmark-Rate“Households could…experience a significant shock if house prices were to reverse.”

That a primary conclusion from the Bank of Canada‘s Winter Review released last week.

We list some of the report’s more intriguing findings below…

The Debt Life Cycle

  • Indebtedness peaks in the 31–35 age range.
  • Mortgage credit is the #1 driver of total debt.
  • Households that have “higher expected future earnings” will often respond by “raising current spending” (e.g., It’s not uncommon for people to use future earnings to justify buying more expensive homes today.)


(Click to enlarge)

Debt Growth

  • In the past 30 years, the ratio of mortgage debt to disposable income has risen from ~50% to almost 100%.
  • “The large increase in total household debt since 1999 consisted primarily of home-equity extraction…which increased from around 2.2% of disposable income in 1999 to a peak of 9% in 2007.”
  • “The increase in home-equity extraction consisted mainly of net mortgage refinancing which could be partly explained by rising housing prices from 1999 to 2010.”
  • Draws on HELOCs have also risen signifi­cantly since 1999.
  • In 2009, net draws on HELOCs represented almost 1/4 of the total increase in household debt. (Households may have borrowed to compensate for the temporary decline in income during the recession.)

Mortgage Affordability

  • Despite rising home prices, income gains and low interest rates have supported affordability, which has led to “significant increases in home ownership and mortgage debt.”


(Click to enlarge)

On the Financial Crisis

  • “A distinguishing feature of the recent financial crisis…is that countries with the largest increases in both their house prices and their ratios of household debt to income in the decade leading up to the crisis tended to experience the largest contractions in consumption during the subsequent recession.”
  • The U.S. subprime mortgage market grew to ~14% of outstanding mortgages before the financial crisis, versus only ~3% in Canada.

What Drives Home Prices

  • One model cited by the BoC attributes 2001 to 2010 home price gains to the following:
    • Increasing population 33%
    • Rising incomes: 24%
    • Declining mortgage rates:  13%
    • Other (including “a recovery from the sluggish price growth of the 1990s”):  29%

The Risk of Falling Home Prices

  • Simulations suggest that a 10% decline in house prices can generate a “peak drop in consumption of about 1%.”
  • “Given the increase in household indebtedness, the exposure of households and the financial system to fluctuations in house prices has increased markedly.”

Miscellaneous Factoid

  • The spread between the typical interest rates for unsecured consumer debt and a secured HELOC is approximately 250 basis points.

Rob McLister, CMT

  1. Excellent article once again Rob.
    Especially noteworthy is the mortgage affordability graph, which clearly illustrates the stark differences between now and the last big real estate crash in 1989.
    No comparison.

  2. Appraiser, that chart shows the rest of Canada, i want you to say the same to the real unaffordable cities which are Vancouver and Toronto where almost half the population live.

  3. It’s not even close… of course it’s interesting to see what would make it close.
    For example if you assume that interest payments are 2/3 of what first-time buyers pay monthly, and the current affordability ratio is 0.25, then an increase in mortgage rates of 150% would double the monthly costs and put the ratio back to where it was around 1990 (over 0.5) and likely cause some quick changes in price.
    For a lower target, it seems like the ratio doesn’t go over 0.375 for long. That would be a 50% increase in monthly costs. A 75% increase in mortgage rates would put us there and possibly make further price increases very unlikely without necessarily causing a crash.

  4. How can you compare longitudinally with a graph like this? It is corrected for house prices, interest rates, and income, but not for LTV — it assumes a 20 or 25% down-payment. Average LTV for first-time buyers in 2011 was in the 90-95% range. Most first-time buyers are not “enjoying” the affordability suggested by this graph.

  5. Joe Q,
    First you must understand that not all buyers are first time buyers.
    Second, if you want to compare longitudinally then you must realize that today we have 30 year amortizations and higher TDS limits. That offsets much of the down payment factor you mention.

  6. Speaking of affordability, recent GTA data from TREB indicates that 52% of all home sales are under $400,000. Only 4% of sales are over $1Million.
    Which should help to illustrate how deceiving averages can be, considering the average is $468,000.
    With more than half of all buyers in the GTA purchasing homes well under the average price, it is a safe bet to assume that this segment of the market represents the vast majority of first-time buyers.
    Buyers in the higher price categories typically have existing homes to sell, which have appreciated substantially over recent years, providing move-up buyers with a hefty down-payment on their new digs.
    It’s a healthy market all-around in my opinion, with first-time buyers still able to get a foot in the door, allowing existing home-owners to sell and to continue to climb the property ladder.

  7. “Note that we assume a 95 per cent loan-to-value ratio…”
    Guess you missed that little detail, huh Joe Q??

  8. Comments on the Role of a Mortgage Advisor on mortgage debt? I have advised clients that even though I can approve them, they are taking too much debt. Should you as an advisor give your input on debt levels or keep your work more technical and give them the approval they want… Camilo Rodriguez, AMP

  9. If you can approve them, then who are you to say that they are taking on too much debt? By what measure?
    By all means, educate the client but don’t judge them!

  10. My mistake — the much more commonly cited RBC Affordability Index is based on a 75% LTV. In any case, my point still stands — assuming a constant LTV distorts “affordability”, because LTV has changed dramatically over time.
    Why project a 95% LTV back onto 1980s housing prices? How many people got mortgages with 95% LTV in the 1980s?

  11. They assume a 95% LTV for the calculation in the link you’ve provided, but that data is not the same as what’s provided in the latest report. Nowhere in this report does it say that they assume a 95% LTV.

  12. The context of the affordability calculations here is first-time buyers (according to the report) who tend to (but not always) take the highest LTV they can.

  13. NO. Your point does NOT stand.
    If someone put down 5% in 1980 then affordability would have been X.
    If someone puts down 5% today then affordability is Y.
    X and Y have remained comparable over the last 30 years due to falling rates and rising incomes. That doesn’t even factor in today’s higher amortizations and more liberal debt ratios, both of which also improve affordability.
    Stop fighting the facts man.

  14. If someone put down 5% in 1980 then affordability would have been X.
    You need to tell us who put down 5% in 1980. Were those high-ratio mortgages even available? Would the CMHC have insured them?
    If no-one could get a 95% LTV mortgage in 1980, why bother calculating 1980 affordability based on it? It makes the mortgages of that era look much larger than they actually were.
    That doesn’t even factor in today’s higher amortizations
    Yes it does. Re-read the report. The data is adjusted based on the maximum allowable amortization length insurable by the CMHC.
    Stop fighting the facts man.
    So what you’re saying is that the affordability chart should be corrected for changes in income, house prices, interest rates, and amortization length, but not for down-payment size?
    You really think it makes sense to calculate how affordable Canadian homes were in 1980 based on a 5% down-payment?

  15. You get paid either way, right? It’s not like you have to put up a bond of your own money for approving them, or anything. (Which would be an interesting system . . .)

  16. Appraiser (or others),
    Any thoughts on why inventory is so low?
    If its a healthy market with existing owners able to sell and climb the property ladder, then why aren’t they listing/selling?

  17. Joe Q,
    Note 12 at the bottom of page 11 states:
    “12 This measure is the same as the affordability series available on the Bank of Canada’s website
    (reported in the Credit Conditions dashboard at <
    financialconditions#hai>), with the exception that it uses historical data for the maximum amortization
    period rather than assuming a constant 25-year maximum amortization.”
    So it seems that they are indeed using a consistent 95% LTV for their comparison. However, they are using different amortization periods (presumably a blended avg lower than 25 yrs for the pre-2000 data points, and a blended avg higher than 25 yrs since the changes in the max amortization period in the 2000’s and esp post-2006).
    I wonder why they don’t include the effect of closing costs on higher purchase prices (ie realtor fees, LTT’s,) and why they don’t include property taxes on higher property values?
    I would think those are relavant costs for an affordability index. Aren’t those costs are serviced from income and therefore not more affordable in times of low mortgages?
    Can someone help me understand why those wouldn’t be included?

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