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Blog by Kevin Wong

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Is Record Household Debt A Problem For Home Owners?

Continuous bad news about rising Canadian debt has been making headlines for the past few years – and now we’re hearing over and over again that mortgage debt has reached epic proportions.

Is all of this negativity accurate? We decided to find out by asking some credible sources.

The truth about household debt

It is true: the overall household debt of Canadians is at a record $1.5 trillion, growing from $147 billion in 1982. Two-thirds of the increase from 1982-2010 occurred from 1999-2010.

The largest component of debt among households is residential mortgages which account for two-thirds of all household debt. This debt has kept pace with home prices, and is larger in BC and Ontario than other provinces.

In 2010, residential mortgages represented about 68% of total household debt. This compares to a low of 63% in 1971 and a high of 75% in 1993, during the 1971-2010 period.

Why have we seen high mortgage debt?

The reasons include:
• historically low interest rates which allowed households to increase borrowing activity including home equity loans for
home improvements, cars and vacations;
• rising household income and net worth which allowed households to borrow larger amounts;
• financial product innovations (low downpayments and longer amortization periods) that let Canadians carry a larger debt
load, since they allow for lower monthly payments;
• rising home prices boost debt since larger amounts must be borrowed; and
• beginning in 2009, sudden lower income growth as a result of the global economic depression.

Mortgage holders are also typically younger, who have bought their home within five years, and who carry higher mortgage debt than those who have been in their homes longer.

How does mortgage debt compare with other debt?

• In 2010, residential mortgages represented 58% of total household debt held by chartered banks. Consumer credit
accounted for 42%.
• Credit cards as a share of household debt held by chartered banks remained constant from 1982 to 2010 at 7% per year.
• In 2010, the share of personal loans significantly decreased to 10% from 39% in 1986.
• In 2010, the share of personal lines of credit increased to a whopping 25% from 3% in 1986 indicating that consumer
and credit card debt has considerably outpaced mortgage growth.
• CMHC’s mortgage arrears rate is 0.42%.

What measures are getting us back on track?

Since 2010, the Federal government has introduced significant changes to mortgage insurance rules. These included:
• reducing to 30 years from 35 years the maximum amortization period for government backed insured mortgages with loanto-value ratios of more than 80% (effective March 18, 2011);
• reducing the maximum amount Canadians can borrow to refinance a mortgage to 85% from 90% of the value of a home (effective March 18, 2011);
• withdrawing government insurance backing on non-amortizing home equity lines of credit (effective April 18, 2011); and
• requiring borrowers of non-occupied property for speculation to have a minimum downpayment of 20% instead of the
previous 5% (effective April 19, 2010).

The goal of these changes has been to significantly reduce the total interest payments on mortgages so that Canadians can more quickly build equity in their homes.

Has it worked?

Yes and no.

After the implementation of changes to mortgage lending rules in 2011, home owner refinance activity initially fell by nearly 40% according to CMHC. By the end of September refinance activity had moderated to 25% below pre-implementation level. The resulting year over year decrease was 31%.

At the same time, the new rules also affected the mortgage insurance market which resulted in an 11% drop in insured units.

The good news is that these factors “suggest that the growth of household credit will likely moderate from the pace observed in early 2011 to a rate closer to disposable income,” according to the Bank of Canada.

Mortgage equity – how are we doing?

Today, most Canadian home owners with a mortgage have significant equity in their homes. (See pie chart below).


Source: CMHC, Canadian Housing Oberver, 2011

Even more safeguards are now in place

The June 2011 Federal Budget introduced legislation that formalized mortgage insurance arrangements with private sector mortgage insurers similar to that of CMHC. The same rules for government-backed mortgages now apply to private insurers.

As well, amendments were made to the National Housing Act that include regulations which specify criteria for CMHC-approved lenders and for loans that CMHC is permitted to insure.

CMHC now requires borrowers to:

• qualify for a 5-year fixed-rate mortgage even when they choose a mortgage with a lower interest rate and a shorter term; and
• have a credit score minimum of 600 with only some exemptions for borrowers who are low credit risks.

Home buyers are still able to buy a home with a 5% downpayment.

Good debt, bad debt

What are the key risks that affect Canadians’ ability to pay their mortgages? They are recession, job loss, and the potential for falling home prices and rising interest rates.

Right now, most households are able to ride out adverse economic conditions for three reasons, according to CMHC:

1. In Canada we have high quality mortgage credit. Last year’s round of mortgage rule changes continues to reinforce the stability of the our housing market.
2. Most Canadian home owners with a mortgage have substantial equity.
3. Most Canadian home owners are able to adapt their discretionary spending.

If the goal of the federal minister of finance is to stop home owner debt from rising, then he can claim some success because we see Canadian’s have finally begun to start paying down their debt. If the minister chooses to further tighten financing rules, could this potentially slow growth in the housing market?

Debt can also be bad when it’s used to pay for current consumption with high interest costs. But, on the other hand, some debt can be good – when it’s used to buy a home, which is a durable asset and normally appreciates over time.