Title: Are Canadian households carrying too much debt?
Sub-title: Canadian families appear to be able to handle current record borrowings. However a sharp rise in interest rates could change things.
Last week, in a bid to ally fears that the country’s residential real estate market may be heading for bubble territory, Canada’s finance minister Jim Flaherty announced new steps to tighten up mortgage credit. “Canada’s housing market is healthy, stable and supported by our country’s solid economic fundamentals,” said Flaherty. “However a key lesson of the global financial crisis is that early policy action can prevent negative trends from developing."
As a result of the new rules, all new borrowers must now meet the higher standards needed to qualify for five-year mortgages, even if they choose those that offer shorter terms at lower interest rates. In addition, the minimum down-payment that buyers who do not plan to live in the properties that they purchase (mostly investors and speculators) need to come up with, has been raised to 20 percent. And lastly, the maximum loan amount that Canadians who do home re-financings can now withdraw, has been lowered to 90 percent.
On the surface, Flaherty’s move make sense. Canada’s banking industry, which has widely acclaimed as one of the world’s soundest, escaped much of the agony that befell its US counterpart during the financial crisis. As a result, there’s a good argument to made that erring on the side of caution may not be such a bad thing. That said, the move raises questions of just how serious the indebtedness of Canadian households is.
The Canadian housing market
While Canadian families are now carrying more debt than ever before, to evaluate just how serious current levels are, one needs to compare them to the value of the assets they own. The good news, it that according too the Canadian Real Estate Association, residential properties, which constitute most families’ main asset, have been doing quite well.
The average price of homes sold via CREA’s Multiple Listing Service during January rose an impressive 19.6 percent compared to one year ago, to $328,537. That said, according to Pascal Gauthier, an economist with TD Bank Financial Group, price gains will likely taper off during coming months. “We expect growth to cool gradually heading into 2010,” wrote Gauthier in a recent note to bank clients. “Sales momentum has eased from the summer of 2009. A substantial increase in new listings and an easing is sales have softened the market balance significantly, which in turn has led to slower month-over-month price growth.” If Gauthier is right that price gains will weaken (as opposed to going into outright decline), that would be particularly good news, particularly in light of the fact that current levels are extremely attractive from a historical perspective.
In fact residential real estate is doing far better in Canada than it is in the US, where prices have fallen in the double digits in almost all major markets. According to Benjamin Tal, an economist at CIBC World Markets, residential real estate resale values could fall by between an additional 5.0 and 10.0 percent, once tax support from the US government’s stimulation initiatives for the sector starts to level off.
Household indebtedness in Canada
Canadian stocks too have done well. While they are nowhere near their historic highs, the S&P/TSX composite index is up by more than 40 percent from last year’s lows. According to Mark Pinsonneault, an economist with Natiaonl Bank Financial, the big problem is that while assets of Canadian households have bounced back since their financial crisis lows, they haven’t bounced back enough to keep up with their current rate of borrowing.
“Canadian debt levels have progressed normally (during the past 18 months) at a pace akin to that of previous years,” says Pinsonneault. “However the deterioration in financial assets following the collapse of the stock market during that time, caused household debt to rise by four percentage points to 24.7 percent of net wealth.”
On the positive side says Pinsonneault, current low interest rates make it far easier for Canadian households to handle their debts. During the third quarter of 2009, the effective interest rate on Canadian household debt, was just 5.39 percent, compared with 12.0 percent during the early 1990s.
“No matter how you look at it, Canadian households are in a decent financial position,” says Pinsonneault. “The real test will be what happens when interest rates start to rise, which they are expected to starting at about mid-year.”
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