Canada

Canada’s Highly Indebted Households Are About To Feel The Pinch From Rising Rates

One of the world’s largest economies is handcuffed to over-leveraged home buyers. An analysis from Oxford Economics looks at two rate hike scenarios in Canada. Tony Stillo, the firm’s chief economist, expects the Bank of Canada (BoC) to hike interest rates slowly. If the central bank takes this path, all households will bear the burden of higher inflation. However, mortgage repayment would see a minimal increase. If the central bank pursues a more aggressive schedule to fight inflation, households feel a bigger pinch. 

Canadian Households Owe $2.5 Trillion In Debt

Canadian households have loaded up on mortgage debt during the pandemic. Total household debt reached $2.5 trillion in Q3 2021, driven by $193 billion in mortgage debt since Q4 2019. Mortgage debt represents 68.7% of household debt in Canada, up 4 points over the same period. Households accelerated their mortgage debt through the pandemic. It might cost them a lot more than they anticipate in just a few months. 

BoC Forecast To Hike Rates Slowly, Embrace High Inflation

Oxford Economics has forecast one of the least aggressive rate hike schedules. They see the current 0.25% rate holding until Q4 2022 and rising gradually to the “neutral” level of 2% by mid-2026. That’s a very slow increase and unlikely to resolve inflation issues.

The firm sees the BoC embracing higher inflation to ensure the comfort of debt holders. Which would be swell, no? If you didn’t borrow as much as you could, your reward is seeing your purchasing power fall. In a way, households would be subsidizing indebted households to make payments more manageable.

Stillo estimates a very manageable increase to the average payment in this scenario. They estimate the debt service ratio (DSR) would increase from 6.3% in Q3 2021 to 8.2% in Q4 2023. It would be the same level of burden seen in 2018-2019 when the BoC last hiked rates.

The firm estimates the average mortgage payment would rise $86 in Q4 2023 and $236 in Q4 2026. Not exactly earth-shattering, but not insignificant. If a median 30-year old diverted this cash from their retirement planning, it would produce a $200k shortfall by the age of 65. Small changes can have a material impact. That’s the reason people lend money, though.

If The BoC Hikes To Curb Inflation, Indebted Households Will Pay A Lot More

Canadian households are in for much higher debt payments if the BoC tries to fight inflation. They forecast the central bank would begin hiking rates early next year in this scenario. Interest rates would hit the neutral 2% by mid-2023, more than three years earlier than in the ideal scenario. The more aggressive schedule is more in line with financial institution forecasts. 

Aggressive hikes to curb inflation would lead to a sharp increase in the debt burden. Households would see their DSR rise above the 2018-2019 peaks during the last rate hikes in Q4 2022. By Q4 2026, we could see the DSR hit 10% — matching the pre-Global Financial Crisis high. The average mortgage would rise $166 by late 2023 and “…strain household finances.”  

When most people hear “strain household finances,” they think mortgage defaults. All hell breaks loose, and the world ends. That’s not the case. These highly indebted households would most likely just reduce their consumption. 

Reduced consumption sounds terrible until you realize it happens in either scenario. If indebted households don’t reduce consumption due to higher rates, inflation stays elevated. If inflation is elevated, everyone reduces consumption as buying power shrinks. Extend low rates to save highly indebted households, or save the whole population from taking a hit? Tough one, I know. 

Inflation being a widespread issue is why institutions are betting on hiking soon. National Bank of Canada (NBC) said the recovery would be in jeopardy if rates don’t rise next quarter. Scotiabank has also forecast eight rate hikes over the next two years. That’s similar to Stillo’s aggressive scenario. In any case, it might be time to redraw that budget if you’ve been on a mortgage debt binge recently.

14 Comments

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  • PK 5 months ago

    No worries, no matter what Bank of Canada is not going to raise interest rate and housing price will keep going up.

    • SC 5 months ago

      Enjoy your own Babel tower while it lasts.
      Collapse is instant to feel nothing

  • Kris 5 months ago

    Well this is just getting beyond depressing!

    I am glad they want to protect the people that over leveraged themselves and hell with the ones that saved.

    Being a saver I have completely screwed myself into a much higher mortgage and down payment – if i buy – and just hope the BOC keeps holding our hands and saving us from reality. Or stay renting and watch my cash dwindle down to nothing thanks to inflation. Super fun options. Buy something that is overpriced that I see basically no value in just because it is going to go up (aka gambling with my life savings) or rent with no stability of putting down roots and possibly watch my savings get eaten up in inflation. Super fun choices.

    Anyone have a third options 🤔 Cause I am not super keen on the ones I have!

    K

    • Derek 5 months ago

      I agree but you could invest your money in ETFs low cost dividend paying ETFs and receive a dividend with the money you’ve saved. I do agree though that the government has totally screwed over prudent people over ones who don’t have a problem over leveraging their lives. Total disgrace. Not to mention not free market at all.

    • Diane 5 months ago

      Rent where you live and buy where you rent. Or buy a cheaper place in a rural area as your second home. We have to get creative.

    • Sam 5 months ago

      Crypto, and stay in your apartment.

    • John 5 months ago

      What age groups are holding this Mortgage debt and what age group are holding the assets.

  • VNM 5 months ago

    In a friend’s midtown TO apartment building 1/3 of the units are vacant,
    the owners don’t want to reduce asking price, wonder how common that is?

    • DasHip 5 months ago

      .. Vancouver’s been like this for years, man.. Glad your starting to feel it over there in ON too. Maybe eventually y’all will do what should have been done years ago — walk over to Ottawa with pitchforks already.

    • D 5 months ago

      Tallest residential condo unit in Canada and Toronto is a luxury condo where less than 20% of units are occupied.

  • RainCityRyan 5 months ago

    Doesn’t really matter what the BoC try, it’ll all come down to the Fed.
    If the Fed raises the BoC will have to follow to defend the Loonie. It might not be one for one (though I think the BoC will try to get out in front of the Fed), but it’ll be the same direction and magnitude.
    Otherwise we have a currency depreciating on top of inflation, which is especially bad since the Canadian economy is disproportionately based on international trade.

    And remember determining rate hikes are the same rules as a road trip. It’s the largest bladder that determines the rest stops … not the smallest.

  • D 5 months ago

    Acccording to statscan, 30% of households have a paid off home(s), 36% have mortgage, and 34% rent. Numbers might be different but seeing how there’s 16 million households, $2.5 trillion / 5.76 trillion households = $435,000 mortgage debt for households with a mortgage. That seems like a lot but the average home in Toronto is valued at $1.1 million and a lot of homes are going for $600-900k.

  • Flipg 5 months ago

    Savers, workers, renters, small business owners, new immigrants, anyone foolish enough to participate in the once productive economy of Canada, anyone on a fixed pension… all will be sacrificed to Moloch: the God of Debt.

    The Fed will play the tune and we will dance to it.

  • Mark Bayly 5 months ago

    Incomes are going nowhere so can’t see how house prices can keep going up unless the government moves to negative interest rates. Must be many stressed out people paying for mortgages. Canada is not an easy place to make money. Lots of taxes inflation and competition. And lots of land to build more houses Trudeau is bringing in a million immigrants a year which might help housing but of course will destroy the environment

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