Concerns exist over growing debt levels and reliance on low interest rates
The report, which includes an in-depth look at the Canadian housing and mortgage market, shares the Bank of Canada's concerns that Canadians need to be prudent about adding further to debt levels, but argues that there are a number of factors that will buffer Canadian homeowners from being saddled with mortgages they can't afford.
"Make no mistake:
"One, some mortgage holders will have substantial home equity, even allowing for a house price slide, and could downsize. Two, others have high debt payments because they are making accelerated pay-downs of principal, which they could stop. Three, history suggests that many will jump into fixed mortgages in time to avoid the full brunt of the variable rate shock.
"The result is that the number of Canadians truly at risk could be substantially less than the (Bank of Canada's) estimate."
CIBC's in-depth look at the Canadian housing and mortgage market finds an unprecedented level of volatility over the last two years. After falling on hard times at the beginning of 2009, housing prices, resale activity and new housing starts have seen a remarkable turnaround with the sector now outpacing the rest of Canada's economic recovery.
This rapid uptick in housing activity, in the face of recessionary conditions elsewhere in the economy, has caused many to question whether house prices are rising too quickly given current economic fundamentals. At just under
Mortgage credit is now rising at a year-over-year rate of more than seven per cent and this has helped push the household debt-to-income ratio to a new all-time high of more than 140 per cent, making this the first time in the post-war era when real household credit continued to expand through a recession.
"Given that the current overvaluation is occurring in a context of historically low interest rates, what we are most likely witnessing is a temporary period of exuberance that is "borrowing" activity from the future, as households take advantage of lower rates and accelerate their borrowing and home purchasing activities," says Benjamin Tal, senior economist at CIBC.
While the Bank of
"The reality is that in the past, interest rates have played only a minor role in driving mortgage default rates," he adds. "Historically, it's clear that mortgage arrears rates are highly correlated with the unemployment rate, with little or no correlation with changes in interest rates. The same goes for the economy in general. Over the past three decades, personal bankruptcies have risen twice as fast in an environment of falling interest rates than in an environment of rising rates.
"The logic here is obvious. Interest rates rise when the economy recovers, and the benefits to employment and incomes of an improving economy easily offset the sting of higher interest rates on debt service costs."
In its latest "Financial System Review," the Bank of
The report notes that out of the five million Canadian households who hold a mortgage, only an estimated 350,000 have a mortgage with a loan-to-value (LTV) ratio greater than 80 per cent and a DSR greater than 40 per cent. Add this number to the small number of renters with DSRs over 40 per cent and the share of Canadian households that are "vulnerable" to a rate shock is less than four per cent, notably below the 5.9 per cent starting point estimated by the Bank of
Another factor that will lessen the potential for mortgage defaults is that most Canadian financial institutions issue variable rate mortgages only to customers that qualify for a 3-year fixed-term rate, which today is well above current variable rates. While all borrowers will face the impact of higher rates, most of them will therefore be able to absorb a three per cent rate hike and still remain within the qualification threshold.
"Only mortgages that were underwritten since early 2009 are vulnerable in this sense as their new mortgage rate (prime + 300 basis points) will end up being higher than their qualifying rate," adds
He notes that others in the supposedly "at risk" group have some protection from the initial impact of rising rates by already locking in a fixed rate mortgage. "Based on information obtained from CMHC, no less than 80 per cent of households who took a mortgage in 2009 with an LTV greater than 80 per cent and a DSR greater than 40 per cent have a fixed rate mortgage. In general, low income Canadians tend to rely more heavily on fixed rate mortgages - the complete opposite of the situation south of the border where low income Americans were heavy users of variable rate mortgages."
He adds that while even fixed-term mortgages will eventually be reset, the longer time frame for any hikes in their borrowing rates leaves them with more time to pay down principal and benefit from rising incomes before that hits.
At the same time, many Canadians have taken advantage of low mortgage rates to accelerate their mortgage payments. No less than 40 per cent of mortgage holders accelerate their payments by adding a full month of extra interest payments each year. On a
"Add it all up, the level of vulnerability in the mortgage market is not as high as suggested by the Bank of
"While other adjustments to practices by participants in the mortgage market could be examined as a means of enhancing prudence, one should be careful to avoid excessively denting the health and flexibility of the housing market as a whole."
After all, he notes, the lessons for the U.S. were not that an extended period of low rates caused a mortgage and housing blow-up. "While (former U.S. Federal Reserve Board
The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/sdec09.pdf.
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