You may have noticed more experts in the media suggesting that too many borrowers are gorging on low-rate debt and putting themselves at risk.
Last week, prominent Canadian investor and business magnate Stephen Jarislowsky became the latest to warn of a growing danger of mortgage defaults.
“It's not necessarily a bubble if interest rates stay low indefinitely,” he said during an interview on BNN. “If at some point we have to increase interest rates, it's going to be a massive default in mortgages if the mortgages are too high a percent[age] of today's values.”
David Rosenberg, Chief Economist at Rosenberg Research, added his own ominous warning, saying we could be in “one of the biggest bubbles of all time.” Canadians have heard that before, but is it finally time to worry about an explosion in mortgage defaults?
The short answer is nobody knows for sure.
The long answer is likely not.
Here are some of the reasons why mortgage default risk may be slightly overstated.
- The “stress test.” Despite today’s borrowers gobbling up mortgage rates below 2.00%, they still must prove they can afford mortgage payments at interest rates as much as three times their actual contract rate. At a minimum, all but non-prime borrowers (a small fraction of the market) must show their income is high enough to handle payments based on the Bank of Canada’s benchmark rate, which is currently 4.79%.
- Renewers don’t need to requalify. The overwhelming majority of those with a maturing mortgage face little renewal risk. That’s because they don’t need to requalify if they stay with their current lender. Only those wanting to change lenders have to get re-approved.
- People will likely make more. The average wage goes up over 2% a year. That’s about enough to cover the higher payments resulting from a one-percentage-point jump in interest rates, given an average mortgage balance and average household income. But that’s not all. Ottawa’s support packages boosted incomes significantly in the last 12 months, and mortgage deferrals allowed many to sock away emergency cash. As a result, most Canadian homeowners are in a stronger financial position today than at the start of last year.
- Defaulting is always a last resort. Most conventional borrowers have options if times get tough. For one thing, most can refinance (e.g., extend the amortization to lower payments or pull out equity), even if it’s with a higher-cost non-prime lender. Some may even tap lines of credit or retirement savings to make payments short-term, or, heaven forbid, a credit card. Worst case, assuming sufficient equity, they could choose to sell. Mind you, that’s easier in a strong housing market than in a correcting market. But if the borrower is proactive and contacts the lender before they miss a payment to ask for more time, the lender may allow enough time to sell or refinance elsewhere.
- Mortgage default rates are perennially low. As of December, Canada’s default rate was a mere 0.23% of outstanding mortgages. That’s below the long-term average and practically unchanged from three years ago, despite a global pandemic and a surge in the national unemployment rate. Granted, mortgage deferrals helped, as did a strong housing market—which allowed quick sales at favourable prices.
In essence, mortgage defaults could easily be higher one year from today, especially if prices over-stretch further. But we must be careful about jumping to conclusions based on what a talking head is telling a reporter. As the above factors suggest, barring another major economic crisis, defaults should stay under control.
