Canadians going deeper into debt of particular concern if rates rise

[REUTERS/Mark Blinch/Files]

Canadians are going deeper into debt amid low borrowing rates, a trend that is causing concerns about a cash crunch for many households if interest rates rise.

The Bank of Canada, which monitors household “vulnerabilities” related to debt levels, said again last week that these vulnerabilities “edged higher,” a sign that debt levels are increasing. Amid low interest rates, Canadians are signing up for mortgages and borrowing to support spending.

The ratio of household debt to disposable income rose to a record high of 165.4 per cent in the fourth quarter of 2015, Statistics Canada said last month, as mortgage debt rose 6.3 per cent during the year. The ratio means that for every $100 of disposable income, households held $165.40 in debt.

“I’m worried about the vulnerabilities, because I think people have so much debt,” said Sadik Adatia, chief investment officer for Sun Life Global Investments. “Mostly mortgage debt, but I’m also worried about consumer debt spending.”

The Bank of Canada lowered its benchmark interest rate twice last year amid the oil price shock and a mild recession in the first half of 2015. The central bank’s overnight lending rate is a guide for bank lending and has encouraged more borrowing, mortgages and home buying.

Economic growth has been slow and economists don’t expect the bank to make any moves to raise interest rates until growth picks up in late 2017. The bank is expected to raise rates incrementally to soften any impacts on consumers and household interest payments.

The bigger the debt, or mortgage, the more that monthly payments would increase with a hike in interest rates. The concern is that if interest rates rise or homeowners are laid off from their jobs, they wouldn’t be able to make their monthly bill payments.

“It’s certainly something that you find in the very broad basket of risks that confront the Canadian economy,” said Steven MacKinnon, a Liberal MP and member of the House of Commons finance committee, which heard from Bank of Canada governor Stephen Poloz on Tuesday.

MacKinnon said the Liberal government is making efforts to increase incomes for those vulnerable households through the expanded child-care benefit and tax breaks.

“Once interest rates do start to go back up, the very vulnerable borrowers out there will very likely face a certain amount of difficulty in trying to finance those obligations,” said David Tulk, head of global macro strategy for TD Securities. “It’s a definite medium-term concern.”

The Bank of Canada said in a report in December that younger homeowners in Toronto and Vancouver held most of the risk in the housing market, and that households with debt exceeding 350 per cent of gross income had risen to 8 per cent, up from 4 per cent before the 2008 recession.

“As a general rule, the higher the mortgage, the more sensitive one is to interest rates,” said Robert Hogue, an economist for RBC. “We think the Bank of Canada will move gradually, and therefore it’s unlikely (there will) be a shock to the housing market.”

Hogue co-wrote an RBC Economics report in February that said housing affordability issues, strongest in Toronto and Vancouver, had exacerbated due to price increases, especially for single-detached homes.

‘Breaking up’ with cities

Vancouver and Toronto have become “dangerously” unaffordable as prices for single-detached homes in those cities have skyrocketed, the report said. That’s made homeowners in those two cities more sensitive to rising interest rates.

Vancouver’s affordability has reached an all-time low, the report said, noting “it is has never been so unaffordable to own a single-detached home in the Vancouver area.”

Homeowner costs as a percentage of household income were over 80 per cent in Vancouver, the highest in the country, followed by Toronto at nearly 70 per cent, according to the RBC report. Calgary, which has been hit by layoffs following the skid in oil prices, was also high, at about 60 per cent.

Some people are dealing with higher housing costs by moving to less expensive cities. Vancouver’s high costs have led to the expression that people are “breaking up” with the city as they move away.

Jennifer Fox, a social media co-ordinator in Vancouver, wrote a trending blog post to that effect last month, saying she was moving to Halifax.

“Goodbye Vancouver, you should go and love yourself,” Fox’s blog post was titled.

Hogue said households are now more sensitive to layoffs than an upward move in interest rates.

“We’ve seen in provinces such as Alberta a sharp rise in unemployment, and certainly this represented a bigger risk at this stage than any rise in interest rates,” Hogue said.