Bank of Canada Governor Mark Carney has been reciting the same message for months now – Canadians are taking on too much debt. Yesterday, Stats Canada released a report that further confirmed this message. The Canadian household debt to disposable income (income after taxes, EI contributions, etc) ratio reached the highest on record for Q3 2010 at 148.1%, which is a 6.7% increase over the previous year. This level of debt even tops the 147.2% ratio of the US for the first time in years.
The Central Bank is concerned about this increased level of debt, which has been fuelled by record low mortgage rates and interest rates over the past few years, because it reduces the average Canadian’s ability to handle a sudden financial shock. This could include things like higher interest rates, which will happen and many economist’s now believe this will be held off until this summer, losing a job, or a sudden drop in house prices. The result would be that people may not be able to keep up with their debt repayments, causing a deluge of personal and corporate bankruptcies.
Mr. Carney’s challenge is that his mandate is to keep inflation under control, which it is, but also to ensure the Bank of Canada’s tools and policies are being used to ‘improve’ the Canadian economy as much as possible. By keeping interest rates at all time lows recently, he has been trying to help Canada get out of a massive recession, which for the most part has happened.
However, many people have been taking advantage of these low rates and taking out additional mortgage and loans that they may have difficulty in paying back in the future. But if he starts increasing interest rates too quickly he may stop the economic recovery in its tracks and send Canada back into a recession.
New mortgage rules
For his part, Finance Minister Jim Flaherty, has been trying to keep Canadians from taking on too much debt as well. Back in February 2010, he introduced new mortgage regulations that were aimed at making it harder for people to qualify for mortgages. The new regulations were as follows:
- All mortgage shoppers need to qualify for a 5 year fixed rate even if they choose a variable mortgage rate or lower fixed rate term (ie. 1-4 years)
- The maximum amount Canadian homeowners can refinance their homes was lowered from 95% to 90% of the value of their homes
- Minimum down payment for house buyers looking to buy investment properties and to get government insurance through the CMHC increased to 20%
It was reported earlier this week that the Finance Minister has been consulting the big banks in his pre-budget consultations and is looking at the mortgage regulations again. He was quoted outside of Parliament as saying if necessary, “We’ll tighten up the mortgage rules more.”
Speculation has it that some of the new regulations being considered are reducing the maximum amortization period from 35 years to 25 years and increasing the minimum down payment required. This would result in making the maximum mortgage amount prospective home owners could qualify for smaller and ensuring people save more before buying a home.
It’s not all bad
On the flip side, a BMO report released yesterday, highlights the fact that the government and media have been focusing solely on the debt side of the equation:
“The continued laser-like focus on debt overshadows the other half of the balance sheet. While debt has risen to record heights, so too have financial assets, due to a rebound in equities and an underlying rise in savings. Taking these factors into account, as well as the recovery in Canadian full-time employment, leads to the conclusion that household finances are not nearly as weakened as the dire headlines would suggest.”
This is supported by the Stats Canada report that said that some of the increase in the household debt to income ratio was “was mainly due to a 1.5% decline in personal disposable income.” The BMO report goes on to conclude that Canadian household finances, have held up quite well through a very extreme recession over the past few years and still has enough of a buffer to handle higher interest rates or lower house values in the future.
So the message is loud and clear. The Government is concerned our debts are increasing more quickly than our incomes, and want to let us know that interest rates won’t be at these low levels forever. Plan for a 1.5% to 2.5% increase in interest rates by the end of 2011, with the hikes starting this summer. Now that we’ve all be warned – let’s see what we can do about it.