Bank of Canada points to hike in homebuyers’ financial stress
The central bank expresses growing concerns over the ability of households to cope with their debts amid higher interest-rate conditions, as more homeowners are beginning to rely on credit cards to manage their expenses because of larger mortgage payments.
According to the Bank of Canada’s annual review of the financial system, there are early signs of financial stress for households and many of them now show less financial flexibility. Recent homebuyers extend their loans in an attempt to make their payments on time. The share of new mortgages with an amortization period longer than 25 years went up from 41% to 46% during the previous year.
The share of new mortgages with a debt service ratio of more than 25% (when the payments consume more than a quarter of the borrower’s income) more than doubled last year and reached 29%.
A longer amortization period raises a household’s vulnerability as it takes more time to build home equity. Meanwhile, a higher debt service ratio decreases flexibility for borrowers who face unexpected hikes in expenses or losses in income. Real estate prices went down by almost 14% since the beginning of 2022.
The increased concern about households raises pressure on the Bank of Canada as it tries to restrain inflation without leading the national economy into a severe recession. As Canadian households are among the world’s most indebted, many economists believe the economy will react faster and be more vulnerable to higher rates than other countries.
“More households are expected to deal with financial pressure in the nearest future as their mortgages are renewed,” – the BoC noted. “The drop in house prices has also cut homeowner equity, and there are certain signs of financial stress, especially among recent homebuyers.”
Approximately one-third of mortgages have faced a hike in payments compared with February 2022, before the central bank began its rate increase cycle and raised its key lending rate by 4.25%. By the end of 2026, almost all mortgage holders will have seen their payments go up, the BoC says. In case mortgage rates change in line with today’s market expectations, the median payment gain during the 2023-26 period will be about 20%.
Although the consequences of the latest turmoil in US regional banks for Canada have been quite limited, funding costs are growing for Canadian banks, and this leads to higher interest rates for consumers.
The Bank’s next rate decision is scheduled for June 7. Most economists polled by Bloomberg expect the central bank to keep borrowing costs unchanged at 4.5% for the third time in a row, even in spite of unexpected inflation growth and a tight labor market.