The Bank of Canada has identified escalating household debt as a problem. What are the implications?
Every six months, the central bank, called The Bank of Canada (BoC), will publish a report called the “Financial System Review”. It’s a boring name but this report is very important to policy makers. It’s purposed to discuss developments and risks in the financial system and provide direction to government policy makers. In the last report, which was published last week on December 15th, the BoC specifically identified three key vulnerabilities related to Canadian households and risks to our financial system.
The first vulnerability they identified was the “Elevated Level of Canadian Household Indebtedness”. Essentially, they are saying Canadians are taking on too much debt.
Have a look at the Chart 2 below. Notice the red line called “Debt-to-Disposable Income” that has risen from around 105% in 2000 to 167% today. This trend line is keeping the Bank of Canada up at night.
The Bank of Canada and policy makers want to see this red bar slowly go down. I don’t believe there is a target range for this measure but they are not comfortable with it at this level. What are they doing about it?
Well, they’ve already taken a recent swipe and reversing this trend through some sweeping mortgage changes as outlined here. Ultimately these changes have made it harder to get approved for a mortgage and therefore, the pricing (i.e. interest rate cost) is higher for homeowners. This higher cost is going to make people think twice about applying for a mortgage. People that could have been approved at the lowest standard rates are now going to be subjected to interest rate premiums. In some cases, it’s unjustified because their loan-to-value (LTV) are lower than the people being approved for the best rates. A low LTV is the best measure of protection against losses for a lender!
So for now, the government is patting themselves on the back with their changes they made. They are expecting this red line to softly descend. However, let’s watch it closely because if the market stays resilient and it doesn’t slow down, we can expect even more changes to lending policies. Although first time buyers are getting raked over the coals these days, I suspect we might see a higher down payment requirement for insured mortgages.
A paradox in lending occurs when someone NEEDS credit, and they can’t get it. Maybe they lost their job and now they need a line of credit to buffer this period of unrest. Good luck trying to get approved without a job! Instead, people should be applying for credit when they don’t need it. This paradoxical advice might be true with mortgage rule changes. Bottom line, even if you don’t need credit today, perhaps now is the time get set up. With fluctuations in housing prices or mortgage rule changes, the ability to get credit later might be hampered, when you need it. (One caveat to this advice, however, is that you must be a disciplined spender. If you spend available credit like an ATM machine then stay away from credit!)
About the Author:
Ian Mucignat, CFA, is an independent mortgage agent at TMG The Mortgage Group. He graduated from Wilfrid Laurier University with a Bachelor of Business Administration, minoring in Economics and is a CFA Charterholder. Ian has worked in the mortgage industry since 2000 at lenders, banks, and brokerages. If you are purchasing, renewing, or refinancing your mortgage don’t hesitate to contact Ian directly for a free consultation.