Bank of Canada worries over financial stress homebuyers undergo
The Bank of Canada is growing more concerned about the ability of households to handle their debt in the higher interest-rate environment, with more homeowners relying on credit cards to meet expenses in the face of steeper mortgage payments.
Early signs of financial stress for households are emerging and many of them now have less financial flexibility, the bank said in its annual review of the financial system published on Thursday. Recent homebuyers are extending their loans to make payments more manageable: The share of new mortgages with an amortization period longer than 25 years rose to 46 per cent from 41 per cent over the last year.
The share of new mortgages with a debt service ratio of more than 25 per cent — that is, where the payments consume more than a quarter of the borrower’s income — more than doubled during 2022, to 29 per cent.
A longer amortization period increases a household’s vulnerability as home equity is built more slowly, while a higher debt service ratio reduces flexibility for borrowers who experience unforeseen increases in expenses or losses in income. Home prices have fallen about 14 per cent since early last year.
The heightened concern about households increases pressure on Bank of Canada policymakers as they try to tame inflation without tipping the economy into a severe recession. With Canadian households among the world’s most indebted, many economists expect the economy to respond faster and be more sensitive to higher rates than peers.
“More households are expected to face financial pressure in the coming years as their mortgages are renewed,” the central bank said. “The decline in house prices has also reduced homeowner equity, and some signs of financial stress — particularly among recent homebuyers — are beginning to appear.”
The share of indebted households that are behind on any credit payments for at least 60 days has been increasing since the middle of 2022. As more homebuyers became more reliant on credit card debt over the past year, the proportion of them carrying an outstanding balance has exceeded pre-pandemic peaks.
Households that took on a mortgage between 2020 and 2022 are carrying about 17 per cent more credit card debt on average than those that purchased between 2017 and 2019. Arrears on credit cards have also been rising and are close to pre-pandemic levels.
About one-third of mortgages have seen an increase in payments compared with February 2022, before the bank started its tightening campaign that has boosted rates by 425 basis points. By the end of 2026, nearly all mortgage holders will have seen their payments increase, the central bank said. If mortgage rates evolve in line with current market expectations, the median payment increase over the 2023-26 period will be about 20 per cent, the bank said.
While spillover effects to Canada from recent turmoil in US regional banks have been limited, funding costs are rising for Canadian banks — a cost that could ultimately result in higher rates for consumers.
“If a severe recession were to occur, the balance sheets of Canadian banks could face pressures through credit and funding channels,” the central bank said, adding that significant unemployment and a large drop in house prices could lead to a deterioration in asset quality and increased credit losses for banks. With weakened market sentiment raising funding costs, “banks would likely reduce the supply of credit to households and businesses as well as that of liquidity to non-bank financial intermediaries.”
The Bank of Canada’s next rate decision is due on June 7. The majority of economists in a Bloomberg survey expect the central to keep borrowing costs steady at 4.5 per cent for a third straight meeting, despite an unexpected acceleration in headline inflation and a tight labor market that continues to churn out jobs.
This article was reported by BNN Bloomberg