Consumer Debt at an All Time High. Is it Time to Tighten Mortgage Rules?
Economic reports are always loaded with numbers and statistics, but one recent number stands out: Canadian consumer debt is over 145% of income, one of the highest ratios in the world. What does this mean for the Canadian mortgage market?
Let’s consider the worst-case (and not unlikely) scenario. If people are currently overburdened with debt and interest rates go up even a little, there could be high numbers of mortgage defaults. While the numbers may not be in line with those in the United States, they will be far higher than anything we have seen here before.
Even if interest rates stay stable, people with huge debt loads could still be pushed over the edge if our economy slows further, or even if its current weak state is prolonged.
How did we get to this point? For some time now, low interest rates have been drawing people into the housing market and tempting them to spend more than they can reasonably afford, especially once interest rates start to creep up. Long amortizations and low minimum down payments have added to the problem by creating an illusion of affordability, even as housing prices have continued to climb.
Given this backdrop, it is no surprise that Canada’s top bankers are asking the government to tighten up the rules for mortgage lending.
While no one believes we are in a housing bubble yet, or even in a credit crisis, the banks are looking for “pre-emptive” action, according to an article in the Globe & Mail. They are seeking a higher minimum down payment – perhaps up to 10% from the current 5% – and a reduction in the maximum amortization period to a suggested 30 years from the current 35 years.
What is really interesting about this request is that the banks stand to lose potential profits. With housing prices growing ever higher, the banks – who control more than 75% of Canada’s mortgage market – could realize tremendous profits on increasingly bigger mortgages. That they are willing to sacrifice those profits in order to prevent mortgage defaults speaks volumes about the potential for trouble ahead.
Mortgages in Canada are insured, of course, which cushions the blow for the big banks, but widespread mortgage defaults could mean that consumers would have trouble paying off other loans and credit card debt. More defaults on more loans would hurt the banks and also cause a slowdown in the economy.
Still, there are potential pitfalls in restricting mortgage lending. Consumers with less access to funds cannot bid as high for a home, so house prices could tumble. Lower housing prices could slow the housing market and cause consumers to curb spending, again slowing the economy.
So which is the right answer? The reality is that Canadian debt loads are dangerously high and there is a real risk of mortgage defaults, especially if jobless numbers do not start going down and interest rates start inching upwards. Preventing people from getting into the housing market for the wrong reasons could help stem the tide in the future.
It may be too late for those who are already in over their head, who will be left with little choice but to devise a debt consolidation strategy to help then regain control over their finances.
