With mortgage rates expected to be renewed at higher levels in the coming years, the Bank of Canada is worried that many households that are overly burdened by debt may not be able to absorb the financial shock. The issue of growing household debt loads was a recurring theme in the recent Annual Financial System Review.
Since last year, the Bank of Canada has acted aggressively to increase its benchmark interest rate to its current high of 4.5%. This was done in an attempt to quell inflation. However, it has also resulted in an increase to variable-rate mortgages. While other mortgages have remained hardly affected by the interest rate hikes thus far, they are still expected to experience some impact in the coming years as facilities are renewed. All mortgage holders are expected to suffer an increase in their repayment amounts by the end of 2026.
The Bank of Canada has also raised concern over the impact of declining house prices that will result in reduced homeowner equity, especially for more recent homebuyers, amongst other indicators of financial stress. Mortgage repayments are expected to grow by as much as 20% over the next three years.
The financial strain on household finances is already being seen as the average debt service ratio was reported to have risen to 19% last year. This ratio denotes the portion of total household income that is spent on covering mortgage payments.
Another indicator of financial stress is the growing number of households using credit cards to service their debts. This has been especially noted amongst home buyers that took up mortgages during the pandemic. Those that received mortgages during 2020 to 2022 were found to have on average, 17% more credit card debt than those who purchased homes in the previous three-year period.
While it was acknowledged that some lenders were providing support and relief options for borrowers struggling to repay debts, some households were said to suffer reduced household flexibility due to the higher rates, lower home equity and extended amortisation periods. Besides the change in rates adding to repayment amounts, more loans are now being extended. In 2019, less than 20% of new mortgages were amortised for over 25 years. Now, about half have been amortised for longer than this.
However, while extending the amortisation period may help bring down payments, it does mean ultimately paying even more interest. If the repayment periods are, however, maintained, the repayment amounts could increase by as much as 40% for fixed-rate borrowers.
While the Bank of Canada is concerned about these issues, it does not consider them a significant risk. With borrowers having been stress tested since the pandemic started and incomes having increased, the situation is deemed manageable.
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