WEALTH Matters — Winter 2010-2011

Consumer Debt and Mortgage Rule Changes

The 2008 market collapse in US Real Estate and global stock markets was largely driven by an over-expansion of consumer and mortgage debt that was not sustainable. Canadian consumers didn’t have the same level of debt load and so were less affected than those in the US, but some economists are concerned that debt levels here are getting too high, which could stall economic growth if interest rates rise.

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Statistics Canada reported in January that Canadian households carry a total debt load that is on average 148% of their gross annual income. Is 150% of gross income really too high a debt level? We don’t think so, especially when the ratio includes the value of the mortgage on the family home. But this figure is an average, so many households are at much higher levels than 150%. This debt needs to be serviced with interest payments, and ultimately needs to be repaid. The cost of these payments reduces the income that remains to be spent on new consumption. The risk is that an increase in interest rates could require monthly interest payments to increase, reducing disposable income, or pushing the household to insolvency. This is what happened with the US sub-prime mortgages, and a similar effect could occur with variable rate mortgages here.


Interest Rate Trends

Investment Market Commentary


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New mortgage rules to take effect January 2011 limit new mortgages to 85% of the home value and a maximum amortization of 30 years (was 95% over 40 years before 2008) and use a maximum loan amount based on a 5-year ‘qualifying interest rate’ regardless of rate chosen. This is to ensure that those choosing variable rate mortgages won’t exceed the ratio if short term rates increase. Even without interest rate increases, households which are barely getting by and not saving any of their income are at great risk of insolvency if a breadwinner becomes disabled or unemployed.

The main risk for those choosing the lower variable rates is the temptation to take on additional commitments using the money they save on their mortgage payments. This would remove the cushion if rates go up, and could result in them no longer qualifying for the mortgage at the time of renewal.

The best advice is to take on only what you can afford to pay while still having the cushion of a regular monthly savings plan that can be reduced or suspended in case the debt payments rise unexpectedly.

Currently, variable rate mortgages cost an average of 2.25% interest per year. The figure in brackets in the below table is the increase in monthly payments required if interest rates increase from the 2.25% rate to the rate at the top of the column. Note that if variable rates increase to 5% then a 30 year mortgage payment increases by over $300 per month – almost a 50% increase in the monthly payments!


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