Canadian households have enjoyed a long period of ultra-low interest rates for the past decade, initiated by the global recession in 2008 and sustained by the oil price meltdown of 2014, as the combined affects hit Canada’s oil-dependent economy particularly hard. These sustained low interest rates have financed high levels of consumer spending and a great deal of activity in housing markets across the country; both of which have been key drivers in our economic recovery.
Borrowing, however, has significantly outpaced income growth, creating a record high debt-to-income-ratio, with household debt standing at 170.4 per cent of income, placing many Canadians in a financially vulnerable position, with credit options tightening up and the cost of borrowing on the rise. Now that our economy has stabilized, interest rates have been creeping up over the past year, pinching most households to some degree and creating a real financial risk for those who are most heavily leveraged.
Risks of Home Equity Lines of Credit and Rising Rates
With sustained growth in the housing market, many Canadians have realized significant gains in their home equity, allowing them to qualify for large home equity lines of credit, (aka heloc accounts), which have become a primary source of borrowing for consumer spending, especially with interest rates being so low for so long. Such lines of credit, however, are often tied to prime lending rates and therefore particularly vulnerable to even a slight increase in interest rates. If you have such a line of credit, you may have noticed the borrowing rate on your statements edging upwards. This isn’t too troubling if you have a low balance, but when you have a balance in the tens of thousands, as many of Canadians do, even a slight bump in the rates can have a real impact on your monthly interest payments:
Canadians have about 3 million heloc accounts and the average outstanding balance is $70,000, the FCAC said, which also warned heloc borrowers are increasingly vulnerable to rising interest rates and a housing market correction. – Financial Post
Risks and Rewards for Variable Rate Mortgages
Another area of short-term risk, in times of rising rates, is for mortgage holders with a variable rate mortgage. In recent years, these mortgage products have typically been offered at lower rates than fixed rate mortgages, making them more attractive. Further enhancing demand for variable rate mortgages was the fact that the low interest rates associated with them were held consistently low for a very long period of time.
In fact, the Bank of Canada had kept its key overnight lending rate at a record low 0.5 per cent for seven years, until last July when it initiated the first of three rate increases in the last 9 months. Variable rate mortgages are typically tied to the lender’s prime rate, which usually moves in lockstep with our central bank’s key lending rate, and is one of the main reasons variable mortgage rates have been steadily rising in Canada for the last year.
Many Canadians are up for Mortgage Renewals and Higher Renewal Rates
Mortgage holders are going to be in for some additional ‘sticker price shock’ when it comes time to renew their mortgage, which will include over 30 per cent of Canadian mortgage holders within the next 3 years. Not only has there been upward pressure on variable rate mortgages in the last year, but fixed mortgage rates are also experiencing significant pressure, driven by rising bond yields in the U.S., the primary benchmark for capital that Canadian lenders rely on to cover the financing for mortgages and other types of loans:
Rising bond yields put direct pressure on mortgages and other loans. And given Canada’s record-high debt burden, that’s no trivial matter. Household debt stands at 170.4 per cent of income. Last year, the Bank of Canada estimated that 31 per cent of residential mortgages with the Big Six bank lenders are up for renewal in the next one to three years. Those borrowers will likely face higher monthly payments upon renewal. According to Ben Rabidoux, president of North Cove Advisors, that hasn’t happened on a sustained basis since the 1990s. Up until now, monthly payments have been falling. – Macleans
The situation for those mortgage holders needing to renew is compounded by the new financial stress test for mortgage applicants:
Higher rates are just half the story. New mortgage-industry rules are complicating the process of taking your mortgage elsewhere if you don’t like the rate offered by your current lender. – Globe and Mail
The new rules, coming into force January 1st, 2018, require all mortgage applicants to prove that they can still make their mortgage payments, if their mortgage rate, or the five-year-average rate posted by the Bank of Canada, goes up by two full percentage points, whichever is higher. This makes it harder for Canadians to shop around, as they would need to undergo the stress test if they apply for a mortgage with a new lender, that is federally regulated, as opposed to simply renewing with their current lender.
Slowing Canadian Housing Market
Rising mortgage rates and new regulations, designed to slow down some hyper-active housing markets across Canada, are indeed having an impact right across the country, with some areas, such as the GTA feeling the steepest declines:
Across Canada, year-over-year home sales fell 16.9 per cent in February and were down in almost three quarters of all local housing markets during the month, according to the Canadian Real Estate Association… The slump was particularly heavy in Toronto with sales plummeting 35 per cent in February compared to the same period a year ago, when a roaring market and double-digit price increases prompted regulators to introduce a range of measures designed to curb demand. – Financial Post
A suddenly slowing housing market is placing downward pressure on home prices, to the tune of a 12 per cent average drop across the country and cutting into home equity, which has been fueling consumer spending as collateral on heloc accounts. As the brakes are being applied to a major household borrowing supply line, what has already been borrowed, and most likely already spent, is costing more to carry.
Mortgages are also getting more expensive with rates for both fixed and variable rate mortgages on the rise, when it comes time to apply or renew. The so-called financial stress test adds an extra layer of difficulty for new mortgage applicants, or those looking to move to a new lender.
Hatch: A Plan That Makes Sense
At Hatch Online Mortgages, we know that getting a mortgage that won’t make you house poor in these uncertain economic times, is essential. We strive to offer some of the best mortgage rates across Canada. Our online process lets us reduce overhead and makes it convenient for you to submit your mortgage application with Hatch. Our highly-experienced mortgage broker, Dan Martel, can also help sort out the right terms and options for your specific home ownership and financial needs. Apply with Hatch now and we’ll get cracking on your dream nest!