Why Cautious Canadians Are Piling on Massive Household Debt

Why Cautious Canadians Are Piling on Massive Household Debt

Why you should care

Because you can move to Canada, but it will cost you.

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Geo facts & figures

The property at 1005 East 22nd Ave. in Vancouver, British Columbia, looks like a nice little starter home — a one-story, two-bedroom, one-bath, 878-square-foot bungalow painted subtle pastel colors. In the yard is a garden with raised beds; downtown is a 10-minute drive.

The listing describes the house as move-in ready but perfect for someone looking to make some renovations. It notes that the property’s most important feature is its price: “Opportunities do not come around like this very often,” the listing reads. “This is your chance to own a move-in ready home in Vancouver at a price we have not seen for a long time.”

And that asking price? Try $1,099,000 CND ($873,820 USD at current exchange rates). It may not be a steal, but it’s definitely a good deal.

Canada’s extremely high housing prices, particularly in Vancouver and Toronto, where the average cost of residential property is $1,046,900 and $744,700, respectively, according to the Canadian Real Estate Association, are among the reasons why mortgages account for two-thirds of Canadian household debt, which reached $2 trillion CND by the end of 2016, according to a Fraser Institute report. When compared to GDP, a 2017 report from the Organization for Economic Cooperation and Development (OECD) found that:

Canada has the highest household debt of the 35 countries monitored by the OECD, with a national household debt-to-GDP ratio of 101 percent.

Compare the sky-high ratio of supposedly cautious Canadians to the average household debt-to-GDP ratio of 63 percent among advanced economies, according to an October 2017 International Monetary Fund study.

Although experts typically recommend spending no more than about 30 percent of income on housing, a RateHub report found that Vancouver homeowners spend nearly 80 percent of their income to keep a roof above their heads, while residents of greater Toronto spent 72 percent in the first quarter of 2017.

Low interest rates are one reason Canadians have had the option to take on higher debt loads, says Royal Bank economist Josh Nye. The average five-year fixed interest rate for a Canadian mortgage in 2016 was 4.64 percent, according to RateHub. That’s been good for the economy while other areas, like business investment, haven’t been performing as well. And, although Canadians have been taking on more debt relative to increases in their household income, they’ve also witnessed rising asset values that simultaneously help improve their financial outlook. “The interesting thing,” Nye says, is that “even though they are taking on more debt, the amount of their income that they have to dedicate to serving that debt hasn’t increased all that much.”

It’s difficult to think about Canadians spending so much on housing relative to income without being reminded of the U.S. housing crisis a decade ago.

This could change, however, now that the Bank of Canada is gradually starting to increase interest rates. Some are worried that beyond the extra money households may spend on servicing their debt, its connection to steep increases in housing prices could signal a coming recession.

OECD economists Catherine Mann and Filippo Gori posted a blog about the report: “The housing cycle is an important risk factor as excessive house price developments are predictive signals of future recessions. … A number of advanced economies have experienced worrying increases in house prices in recent years.”

Insecurity is being felt on the ground too. Dan Garrison, associate director of housing policy for the City of Vancouver, says the cost of homeownership in Vancouver has increased 350 to 400 percent over the past 15 years, while incomes have only increased on average by about 20 percent. The steep increase in the cost of housing, Garrison says, is being driven by foreign buyers and speculative demand. “We’ve had low interest rates for so long now that that’s made money cheap, and I think people have taken advantage of that, but I do think that the high housing costs, particularly in Vancouver and Toronto, are a part of that equation.”

At the same time, Canada’s economy is doing fairly well. Unemployment dropped to 5.9 percent in November, and most households should be able to absorb rising interest rates, Nye says, adding that the Bank of Canada wants to start now, gradually, so that if inflation does pick up, it won’t have to raise interest rates suddenly and by a larger amount.

It’s difficult to think about Canadians spending so much on housing relative to income without being reminded of the U.S. housing crisis a decade ago, when the American household debt-to-GDP ratio peaked at 99 percent in early 2008, according to the Federal Reserve Bank of St. Louis. However, Garrison and others are working to bring the market back to what they think are reasonable parameters, and perhaps, if the current environment is foreshadowing a downturn, trying to manage this ahead of time will lead to a slow deflation to equilibrium rather than a collapse.

And that bungalow on East 22nd Avenue? It was on the market for all of six days and sold just before Christmas for $1,085,000 CDN.

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