Canadian Housing Bubble Is Fueled By Household Debt

Canadian Housing Bubble Caused By Low Rates - Ottawa

Vancouver’s bubble is a lot different from the rest of Canada. They have money laundering, shadow flipping, and have had artificial building restraints until recently. It’s sexy to write about, but there’s still 9,981,792 km² of Canada that isn’t Vancouver, also experiencing a rise in prices. The bubble outside of Vancouver doesn’t read like a box office thriller though, it’s being fueled by plain ole’ household debt. The average price of homes has moved with the size of mortgages that people qualify for, which is a significant contribution to the Canadian housing bubble we’re experiencing.

Mortgage Rates Go Down

The Bank of Canada (BoC) lowered bond rates to provide cheap stimulus…several times. This is done so people have greater incentive to borrow, ideally to start or expand a business. Banks and mortgage companies are businesses too, so they lower their mortgages as well, which has a direct impact on mortgage rates. This has led to a higher availability of capital to buy homes – which has led to a dangerous amount of debt.

The above chart shows how much a household with $100k/year in income could borrow with a moderate credit rating, compared to a scaled index of housing prices across Canada. It’s interesting to note that borrowing rates appear to move at the same pace as mortgage rate cuts.

How That Impacts Housing

Today if you walked into a bank you could borrow 6x your gross annual income. Back when I Kissed A Girl was number one on the charts in 2008, you could only borrow 4x. Experts recommend that you spend 2-3x your gross annual income on a home. Borrowing twice the recommended amount can’t possibly yield great results – can it?

Cheap money has the unfortunate consequence of being easy to spend, so rather than bargaining down homes – people began bidding them up. High asking prices were more easily attainable, since the same person in 2008 could borrow almost 50% more today without any change in their income. The national average of home prices increased by 52% during that same time. Probably just a coincidence though?

Canadians Taking Out Record Debt

Feeling squeezed by your income? You’re not alone. Stagnating incomes, and rising home prices are putting the squeeze on most households. This has resulted in Canadians borrowing more to make ends meet. While most people have been brushing off the fact that it’s mostly mortgage debt – they haven’t considered what happens when rates go up.

While they haven’t, that doesn’t mean the government isn’t worried. Finance Minister Bill Moreau has established a working group to determine what tools they can use to help lower costs. This has resulted in a few high level banking executives anticipating borrowing rules based on a multiple of gross income. Prior to that, former Finance Minister Jim Flaherty was personally calling banks, requesting they keep mortgage rates higher.

Household debt isn’t the only contributor to quick rising home prices, but they are a major one. Determining what’s “affordable” by the payment you can carry today is a terrible idea. One that will hopefully be regulated out soon. Instead people should focus on what they can actually afford, even if rates adjust.

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