Growing mortgage rates may pose a risk to Canadians’ finances

According to TD economist Ksenia Bushmeneva, Canadians’ household finances are generally in good conditions. However, they still depend heavily on low interest rates and growing housing and equity market prices.

BMO economist Shelly Kaushik is highly concerned about Canadians’ personal finances. She points to a 5.4% increase reported in the ratio of household debt to disposable income. As a result, the ratio reached 172.9% in the second quarter (not seasonally adjusted), marking the largest gain since 1990, when they started collecting the data. Such a performance follows six quarters of improvements in a row.

Ms. Bushmeneva also noted a 2.5% quarterly seasonally adjusted hike in overall debt, which is almost double the pace of the previous two quarters. Of course, mortgage debt accounted for a large share of the increase, going up by 3.4% from the first quarter and by 10% from a year ago. Both results turned out to be record high.

Meanwhile, household net worth was up by 3.7% from Q1 and by 19% from the second quarter of the previous year. Moreover, the debt service ratio (the cost of monthly debt payments in relation to a household’s income) fell from 13.5% in the first quarter to 13.3% in the second one. “Although the total household debt rose by almost 7% on a year-over-year basis, the interest payments fell by 4.3%”, – Ms. Bushmeneva said.

In other words, Canadians do have large debts, but they seem to be managing them well today. The housing market activity boom, combined with stronger equity markets that increased the value of pensions and RRSPs, have led to significant growth in net worth that balanced the debt loads.

Nevertheless, the situation will change, if borrowing costs go up sharply or asset prices go down, or especially if both changes happen simultaneously. Monthly mortgage payments will hit the household budgets, while the net worth will fall.

The household finances may be seen as unreliable with the current pace of debt growth, but all changes of the borrowing costs will probably be gradual (the central bank’s Governor Tiff Macklem is perfectly aware of the situation). In addition to it, as the debt servicing costs went down sharply during the previous year, there is some breathing space before interest rates cause a strong financial hit for the average Canadian borrower.

Please keep your household balance in check, have an emergency fund of 3 to 6 months of your expenses and think wisely when borrowing – interest rates won’t stay this low forever.