As the Bank of Canada aggressively moves interest rates higher to combat inflation, many market watchers are raising warning flags for the Canadian housing market. Before one starts looking for a bridge to jump off, it is worth considering what underpins these concerns? The storyline follows that higher mortgage rates will so deplete the homeowner’s disposable income that they will need to visit foodbanks to feed their families or be forced to sell their home at a fire-sale price to escape the crippling mortgage payments. Is this fear warranted? Let us look at the history of the ratio of debt service to disposable income to determine that.
The top blue line shows that Canadian households do indeed have significantly higher debts in relation to their income, but look also at the red dotted line which shows that the debt service ratio to disposable income is in line with its average over the past thirty years.
The reason for this is that the level of interest rates is vastly lower than throughout most of that period. This makes an enormous difference in the size of mortgage that one can afford. For example, a person who could afford a $2,500 monthly mortgage payment in 1990 was able to carry a $325,000 mortgage. As rates have fallen to their current 4% level that same $2,500 carries a mortgage of $475,000, or an increase of 45%.
It is easy to see how the ratio of debt to disposable income has risen by 80%, while debt service has remained unchanged. Mortgage rates need to move significantly higher before these ratios will dramatically impact the ability of most homeowners to afford to stay in their houses. However, as house prices have remained stubbornly high, with mortgage rates increasing, this could prevent new buyers from entering the market. And even for those already in a home, while they may not be at risk of being unable to afford their home, the extra funds that will be required to meet higher mortgage payments will either curb discretionary spending or savings.
Therefore, although higher interest rates won’t necessarily lead to a housing crisis, it may have other implications for the Canadian economy.
Disclaimer: Please note that the publication is designed to provide general information only. It reflects the thoughts and opinions of Logan Wealth Management and should not be construed as financial advice, nor should the information be considered a substitute for personal advice. Information used in this publication has been gathered from sources believed to be reliable. Logan Wealth Management is not responsible for and assumes no liabilities or responsibility for any loss or damages suffered as a result of the use or misuse of, or reliance on the information or content of this publication. Please consult your financial adviser to determine whether the information is applicable to your personal situation.
