Household Debt at a Record-High, With Carrying Costs Set to Rise

One of the greatest bull markets in Canadian real estate history has resulted in Canadians amassing record mortgage debt.

As of April, homeowners owed nearly $2 trillion on mortgages and home equity lines of credit, according to Statistics Canada. That’s a gigantic $18-billion jump from March, marking the fastest monthly increase on record.

Housing mania has driven up another measure of Canadians’ financial wellbeing as well, the ratio of household debt to disposable income. And it’s expected to keep rising for at least the next two years, according to forecasts from Deloitte Canada.

“Particularly in Canada, the housing boom and rising household borrowing remain a key concern,” reads the report.

While that collective debt load is affordable right now—thanks to near-record-low interest rates—borrowers should expect rising rates to take a bite, starting as early as next year. The catalyst will be Canada’s economic recovery, as GDP should return to pre-pandemic levels by the first half of next year, says the OECD.

The risk for borrowers is that the Bank of Canada will have to raise interest rates to tame inflation, perhaps quicker than expected.

As noted previously, markets are betting the BoC will hike its overnight from its current record-low of 0.25% to roughly 2.00%+ over the next five years.

The real risk of rising interest rates

As we get closer to “normal” interest rates, concern about over-leveraged borrowers will grow. After all, Canada’s key interest rate could easily climb to levels not seen since the 2008 Global Financial Crisis — if you believe the bond market’s projections.

Rising interest rates would hit variable-rate mortgage holders first. That's because floating rates move with prime rate, which moves with the Bank of Canada’s overnight rate. Variables typically react to changes in the prime rate benchmark within 1 to 30 days.

All things equal, a 200-bps increase in prime rate would cause the average mortgage payment to increase by $318 per month, or over $3,816 a year. That’s based on today’s average mortgage amount of approximately $327,000, according to Equifax Canada, and today’s lowest nationally available 5-year variable rates.

And while fixed-rate holders will be protected from rate hikes for the duration of their current mortgage term, they could easily face a higher renewal rate when it's time to negotiate their next mortgage. Albeit, with the average 5-year fixed rate near 2.07% today, and 2.82% over the past 60 months, it’s hard to imagine people renewing much above 4%.

This begs a natural question. Can homeowners afford an extra $300+ in interest costs each month, either now or when it comes time to renew?

The answer should overwhelmingly be yes. After all, what would be the point of a federal mortgage stress test, which tests new borrowers at two percentage points higher than their contract rate, if they can’t?

That’s not to say higher payments won’t sting hundreds of thousands of mortgaged households. Affording something and affording it comfortably are two different things.