This article will highlight the growing concern about Canada's economy and household debt in trying to
understand how large the problem is and what you can do about it. Interest rates are still low but have started to rise and appear poised to continue their upward trajectory for the foreseeable future. Canadian household debt is near all time highs. Our household debt is around 170% of disposable income. In other words, the average Canadian owed about $1.70 for every dollar of income he or she earns each year.
In fact, about 8% of indebted households owe 350% or more of their gross income representing a bit more than 20% of the total household debt in Canada. These are the people who would be most affected by an increase in interest rates. It is important for these households to understand how personally vulnerable they may be. The Bank of Canada announced this week that high household indebtedness and housing market imbalances remain the most important vulnerabilities to Canadians and the economy.
Household Stress Testing
We now take our review to the plight of individual households in the context of rising borrowing costs.
Are the short-term gains provided by accessing cheap money leading Canadians towards long-term pain? Are Canadians prepared for higher interest rates and the impact this will have on their ability to meet their monthly household expenses? The writing is on the wall, but are we paying attention to the signs?
Despite the fact that wages have been relatively stagnant over the last decade, Canadians have continued to borrow more and more money to finance their home ownership, lifestyle or other needs. Much of the rise in b o r r o w i n g h a s stemmed from the combination of low interest rates and the bubble-like rise in real estate prices w i t h i n s o m e o f C a n a d a ’s m a j o r urban centres. Many Canadians have been able to profit from the significant rise in home prices. Yet, many of these same individuals have used these gains to buy even larger or more expensive homes fueled by the unlikely assumption that home prices will continue to rise rapidly and the low variable mortgage rates currently available from major financial institutions.
Some Canadians are already struggling to make ends meet relying on credit cards or personal and home equity lines of credit to cover their spending needs. This can lead to debt traps as many Canadians have been using their home as a piggy bank.
While credit card rates will likely remain at their astronomically high historical levels, even the cheaper
means of financing through lines of credit are getting more expensive with the Bank of Canada expected to make another interest rate hike this October. So what do these rate hikes mean in real dollar terms?
Data from the Canadian Real Estate Association shows that the average home sale price in Canada as of August 2018 was $471,045, up about 1% from a year prior. Markets in Vancouver and Toronto are substantially more expensive. Down payments on home purchases in Canada typically range from 5-20%. At a 20% down payment and using the average home sale price, Canadians who purchased a home in recent years would likely be carrying a mortgage somewhere around $376,836 although in cities like Vancouver and Toronto they may be 2 or 3 times higher on average. Homeowners carrying a mortgage with a variable rate will be impacted by interest rate increases almost immediately while fixed rate mortgage holders will not be impacted until they go to renew at the end of their term.
According to Statistics Canada, roughly half a million households have mortgage payments that account for more than 50% of their household income. According to a 2017 survey by one of the largest banks in the country, nearly ¾ of homeowners say they would have difficulty paying their mortgage if payments increase by more than 10%. Another survey found that 1 in 3 Canadians are already unable to cover their monthly bills in light of their d e b t r e p a y m e n t obligations.
It also found that 1 in 3 are afraid they will face bankruptcy if rates continue to rise. The average monthly
mortgage payment as of the end of 2016 was $ 1,328 . T h i s means that roughly ¾ of homeowners
would not be able to withstand an increase of $132.80 to their mortgage payment.
How much will your monthly mortgage payment
increase as result of rising rates?
$500,000 mortgage @ 4.00% 5-year fixed 25 year amortization = $2,630 monthly
$500,000 mortgage @ 4.95% 5-year fixed 25 year amortization = $2,894 monthly (10% increase)
$750,000 Home; 20% Down payment $600,000; Mortgage 25-year amortization @ 4% = $3,156
25-year amortization @ 5% = $3,490
A 1% increase on a 5% mortgage rate is a 20% increase on the interest portion of your payment. Could you still meet your bills if your mortgage payment went from $3,490 to $3,839?
There is more to borrowing than simply, what is the monthly payment. There are a myriad of options and financial terms in a borrowing situation. Perhaps, it might be best to seek out a Financial Advisor, who has more expertise and familiarity with this to assist you with both the positive and negative aspects of the various loan options.
If you are overwhelmed with excessive debt or are considering borrowing, perhaps we can provide you
sound financial advice as to how to best approach it and how you can manage the risks in the years ahead.
Keybase Financial Group Inc. is a member of the Mutual Fund Dealers Association of Canada and the MFDA Investor Protection Corporation (the “IPC”). Keybase is registered with all provincial securities commissions for the exclusive sale of mutual funds and exempt market products, such as: Principal Protected Notes, Alternative Strategies Funds and Hedge Funds. Any data provided is for illustration purposes only. The opinions, estimates and projections provided by a third party are those of the author as of the date indicated and are subject to change without notice. Keybase Financial Group takes no responsibility for any errors or omissions which may be contained therein and accepts no liability whatsoever for any loss arising from any use of or reliance on contents provided by any third party.