Canada’s most expensive real estate markets are the most vulnerable to rate shock. Surprising, we know. Canada Mortgage and Housing Corporation (CMHC), using Equifax data, crunched the Q2 2018 numbers for debt to income ratios across Canada. The numbers show cities with the most expensive homes also have the highest DTI ratios. The high levels of debt relative to income make these cities more vulnerable to rising rates.
Debt To Income Ratios
A debt to income (DTI) ratio is, well… the ratio of debt a household has, compared to the disposable income they earn. Ratios increase when households acquire debt faster than their incomes can grow. The ratio decreases when households deleverage or income grows faster than debt. Ideally, you want to see a strong economy with relatively low DTIs. However, a high DTI by itself isn’t a problem.
Afterall, if the household is making payments and defaults are low, who cares? The problem is when this debt is accumulated at relative lows for borrowing rates. High debt loads at low rates might be manageable today, but as servicing costs rise, they may not be. As rates rise, those with higher ratios are likely to see their service costs rise to unmanageable levels. When households are hit with unmanageable debt, they do things like default or sell assets at a loss. Remember, defaults are a lagging indicator, not a leading indicator.
Toronto and Vancouver Have The Highest Ratios
The highest DTI ratios in Canada were in Vancouver, Toronto, and Victoria. Vancouver households had a ratio of 242% in Q2 2018, up from 226% three years ago. Toronto’s ratio reached a lower (but still high!) 208%, up from 189% over the same period. Victoria trailed closer to the national average with 189%, the same level it was three years ago. To contrast, Canada has a ratio of 171%, up from 165% three years ago.
Debt To Income Ratios For Canadian Cities
The ratio of household debt to disposable income, in major Canadian cities.
Source: Equifax, Statistics Canada, Conference Board of Canada, CMHC calculations, Better Dwelling.
Smaller Canadian Cities Have The Lowest Ratios
Smaller Canadian cities had the lowest ratios in the study, with Saint John, Sherbook, and Sudbury at the bottom of the list. Saint John saw their DTI ratio fall to 106% in Q2 2018, down from 112% three years ago. Sherbrook was the second lowest with a DTI ratio of 132%, down from 139% three years ago. Sudbury was the third lowest with a DTI ratio of 133%, up from 131% three years ago. Yes, even Canada’s lowest debt ratios are above 100%. For context, the US has a debt to income ratio of 109% for the whole country.
Canada’s massive real estate price boom, fueled by cheap debt has grown to epic levels. Canadian households are the most indebted in the world. That gets even worse in larger cities, the major economic engines of the country.
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Remember kids, only half of households in these cities own. Less have mortgages. That means these numbers are averaged down, so don’t think “200% is manageable.”
Insolvency companies need to go public so we can get in on this action.
Check out Invitation Homes. They bought tens of thousands of detached homes in the U.S. foreclosure crisis and now rent them out or fix and flip them. A Canadian equivalent can’t be too far off.
http://www.invh.com/
Possibly because the average Canadian can’t afford a million dollar (give or take a Tesla) house but the pressure (peer, fb, ig, fomo) to do so is enormous.
One bedroom apartments cost $500K (plus property tax, condo fees, maintenance) and people who live in them earn $60K each(be real) the fundamental reasons for real estate valuation have left the building.
The bigger question for me is when did we all lose our minds?
Dr Dre said “What ever happened to falling in love with brother with a bus pass?”
Typo correction: ‘What ever happened to falling in love with a brother with a bus pass?’
He said it January 1 2009, Ed-Ucation
On that note…..
“Mo Money Mo Problems” = The Notorious B.I.G
“No money Mo Problems” = Canadian version
Combined with the fact that the entire millennial generation has never seen prices drop, its no wonder people are obsessed with buying. Its so easy to view home-ownership as get rich quick while you pay yourself rent, but the reality is the price appreciation simply can’t go on forever. GTA sales volumes peaked in mid-2016 and its typically 18-24 months before prices follow the other direction. I suspect we will see this soon more clearly, if we are not already seeing it.
As someone who is at the “typical” home purchasing point in their life, I can say it is extremely difficult to go against the herd when there is so much pressure to buy (media, family, friends). Even older generations who have seen prices drop don’t believe it will happen again. Regardless, you don’t get wealthy following the herd so we will see what happens.
Seconded!
Add the additional pressure of a wife and family age, and you start pulling your hair out.
Then again, it should start falling out soon so I guess that doesn’t matter.
JJ,
To be honest even Gen X kids were either in High School or university the last time prices started to crash. They weren’t home owners and had more frivolous things on their minds. Don’t just blame Millenials. Not to mention, Boomers who actually owned those early 90’s homes and felt the pain are the ones giving their children hundreds of thousands of dollars to keep this bubble going rather than warn them about what is around the corner. Nobody is coming out unscathed from this.
I have been following this blog for more than a year now. Fascinating insights and saved me from buying right at the peak (I am a newcomer to Canada and uninterested in committing to this real estate market based on everything going on)
I know this site focuses on Canada, but I was wondering if you could do a piece on some of the eye popping stuff happening in Sydney/Melbourne?
I see a lot of parallels with the Canadian.
Thanks for this site!
My understanding is that the Aussie’s have a crazy obsession with drawing on home equity (even more so than Canadians), and are also enamored with interest-only loans. I don’t know much about it, but I recommend checking out the podcast below:
https://www.macrovoices.com/349-josh-steiner
It’s almost a year old, but there is some great commentary on the AUS, CAD, and US markets. Spoiler: AUS and CAD bad, US good.
I’m with you sideliner. Been watching the Aussie bust closely and have been wondering about the parallels. Interestingly, the media there is all over it- predicting massive drops, printing stories about the floor falling out, etc. Here though, aside from this site, every bit of journalism on Canadian real estate seems like real estate propaganda – claiming everything will improve, prices won’t drop, things will pick up again, etc. I find it so bizarre. This site is such an important voice. I wish I could find more like this.
https://www.howestreet.com/author/rosskay/
https://www.greaterfool.ca/
What about Debt to Net Equity ? is someone living in Winnipeg with an average $300k house and $225k mortgage — better off than a Vancouver dweller with $1M house and $750k mortgage? The Winnipeger has $75k in equity vs $250k for Vancouver.
How do you define better off? risk or ability to make payments on the debt?
They are levered the same so they have the same upside and downside risk.
Obviously the mortgage in Vancouver is substantially larger so if that person is not making substantially more money than the Winnpeger, then they will have a harder time making payments.
JJ nails it here.
Although balance sheet debt ratio may be the same it’s the net cashflow to debt service that’s a problem.
That’s why a Slurpee in Winnepeg is like a bagette in Paris, or a mouthful of foie gras.
I’m with you jj. I’m renting. Im at the time however in life where I should be buying, 39, 2nd kid on the way but I just don’t trust this market. buying a home will potentially wreak havoc on our family’s current portfolio for the next 15-20 Years. I see too much fraudulent activity in this market headlined by artificial numbers fabricated by the treb (very corrupt organization) as well as fake t4s etc which mortgage lenders failed to verify. Did you know that the treb is allowed to manipulate the data on home buying at their own will without informing the public! What?! So in 2014 apparently that was the first year they included ‘for sale by owner’ properties in the Toronto housing data but they didn’t tell the general public! They led people in Toronto believe that in 2014 there was this HUGE spike in houses being sold in Toronto which led people in 2015 to frantically buy! That’s just one example of their fraudulent activity. I’m also aware of the fact that they are able to manipulate and reorganize data to benefit themselves without any watchdog organization watching over them. So In 2019 they again will fabricate numbers to make the general public feel secure in buying. This fraud will eventually collapse on itself. UnfortunAtely the govt of Canada does nothing about it because so much of their GDP relies on housing! They don’t care about the little guy getting screwed! Ha..what a joke
While I’m a big advocate of people deleveraging and paying down that debt as fast as they can; I find Debt to Income ratio flawed as a good indication or measure of anything. You earn $100k and have a mortgage of $200k; you’re right there at 200%. In all honesty, that means nothing. It doesn’t even take net worth or other things into account.
Totally agree that this can be misleading as the number does not tell us anything absolute, and considers both mortgage debt and consumer debt.
That being said, if we consider (as Ethan has said above) that not everyone is a homeowner and not everyone has a mortgage, the number becomes more interesting. My rough math says that Canada has approximately 14M people (not households) with mortgages. With this in mind, the average Canadian mortgage holder would have a debt-income ratio of over 440%, with that number likely being higher in cities where prices are higher.
It’s only an average. It is useful for comparing our position to where it was years ago. If debt-to-income ratio has grown a lot in recent years (it has), that indicates a more indebted population. Of course, that statistic means nothing to an individual. Like you say, an individual at the average $1 of income for $1.70 in debt – is likely in great shape. If you make $100K per year and owe $170K on your mortgage at a low interest rate with no other debt, then your fine. However, when the average of all Canadians owes that amount, and that average has climbed alarmingly in recent years, then that is a very big problem.
If you visualize a normal distribution, it’s not the average that will bring us down, it’s the tails. And since the average has grown so much, we can assume the tails have gotten “fatter” as well. That right tail is full of extremely indebted people, and they are the ones that will bring the housing market down. An 8% default rate on mortgages in the US brought the entire world economy to its knees.
People don’t service debt with net worth. They service debt with income. That’s why debt-to-income is the more important metric. You can only pay down debt using net worth if you sell. If a bunch of people are forced to do that at once, you know what happens to prices.
Question: Do these numbers include or exclude those without a mortgage? I am assuming if we looked just at those with mortgages, the ratio would be much much higher and be more informative of who is in the most trouble.
They’re all households. Only about half own a house in Toronto, and only half of them have mortgages. A fifth of all mortgages were written in the past 3 years.