Despite astronomical house prices in Canada’s hottest markets and record high debt-to-income ratios, one-third of the country’s households are debt free. But, if interest rates were to rise, many households may be left struggling to keep up, suggests a new RBC Economics report.
According to the big bank, a healthy labour market and low interest rates have been supporting the amount of debt households are accumulating. But, when trends change, homeowners should be ready to adjust.
“There is concern that if we see a sharp rise in interest rates or an employment shock or people suddenly lose their jobs and can no longer pay for their debt, then that certainly is something that we want to keep in mind,” Laura Cooper, an economist at RBC Economics tells BuzzBuzzNews.
In its report, published this week, RBC lays out concerning key points it is monitoring in relation to household debt.
Canadian real estate has been a hot topic in the news lately but Cooper says many headlines are often misleading.
“These negative headlines are focused on aggregate numbers that lump all households into one and really the story is more the household level, the level of debt that particular households have,” says Cooper.
“A relatively low share of households account for the bulk of debt in Canada, so I think it’s just monitoring the concentration of debt that is important,” she adds.
One concerning fact is that households appear to be using funds from lower interest payments to borrow more money, says RBC.
Even though interest rates have declined over several years, the share of income required for households to pay off debt has remained stable during the same time period.
If rates were to go up 100 basis points over the next year, households would have to spend an extra two cents of every $1 income to pay off debt, says the bank.
In turn, this would put more pressure on households to service their debt.
Accelerating consumer credit growth is another troubling point the bank is keeping a watchful eye on.
According to RBC, interest payments for consumer debt are equal to the total interest paid on mortgages, and consumer debt tends to be tied to variable rates.
Compared to rates seen in the 2008/2009 recession, growth remains low but could be problematic if interest rates were to rise.
“It has remained fairly steady over the past number of years despite interest rates declining. So, in an environment of rising rates that would put upward pressure on some households to finance their debt load,” says Cooper.
Along with rising interest rates, many Canadian homeowners will find it hard to cope with debt if a housing correction were to happen.
According to Statistics Canada, an average homeowner’s equity as a percentage of real estate is 74 per cent but that number drops if an owner has a home equity line of credit.
“Consumers may be pressed if they’ve been using the equity in their homes to fund some consumption and so they would no longer have that degree of cushion within their equity in order to be able to fund that,” says Cooper.
Even though changes in interest rates or a housing correction could cause many households to scramble, there are positive points that may alleviate the negative impacts.
The majority of Canadian households have very little or no debt, says RBC.
Last year, one-third of Canadian households were debt free and 25 per cent owed less than $25,000.
Along with little to no debt, many households are paying their mortgages on time — only 0.28 per cent of mortgages are more than 90 days late.
In addition, a majority of homeowners with mortgages have some time before they have to start paying higher rates, as current five-year posted mortgage rates are lower than rates from five years ago.
Most mortgages in Canada are fixed-rate and RBC says households refinancing in the near future will pay lower rates than they are currently paying, providing some adjustment time before rates increase.