Debt Growth is Moderating, BOC Deputy Says

(January 14, 2011)

Higher mortgage rates and stricter mortgage rules are starting to take effect, though Canadians’ debt levels are still too high for comfort. That was the message from Agathe Cote in her first public speech as a deputy Bank of Canada governor on Monday. Here’s a sampling of key points from her address yesterday in Kingston, Ontario:
• The Bank of Canada’s rate hikes and government’s new mortgage restrictions, including more stringent qualifying conditions, higher down payment requirements on rental properties, and lower LTVs on refinances, are “beginning to have an impact” in moderating debt risk.• Since the trough of the recession, household credit has grown about twice as fast as personal disposable income. By the third quarter of 2010, the debt of Canadian households had reached 148% of disposable income. • Cote spoke of the financial accelerator effect, whereby increases in home prices increase household spending. The basic premise is that when house prices rise, so too does the amount the owner can borrow against the increased equity (via HELOCs, home equity loans, etc.). The money can be used on home renos or other goods and services that can accelerate the rise in house prices, which in turn creates access to additional borrowing and boosting household spending. • Cote cautioned that this can also work in reverse: falling house prices reduce household borrowing capacity and amplify the decline in spending. BOC research suggests the financial accelerator effect is “economically significant,” Cote said, noting that the finding is consistent with evidence of a correlation between consumer spending and housing wealth. • Over the last decade, the volume of home-equity lines of credit and loans has risen by upwards of 170% – about double the pace of mortgage debt – and accounts for 12 per cent of overall household debt, Cote said. • A sudden weakening in the housing sector would have a “sizable” spill over effect on other parts of the economy. • “Credit continues to grow faster than income” • A hypothetical 3-percentage-point increase in the unemployment rate would double the proportion of loans that are in arrears three months or more. A side note: If this were extrapolated to mortgage debt, the arrears rate would jump from 0.43% today to 0.86%. The highest that our records show was 1.02% in 1983 (source: CMHC). • Cote said it is the responsibility of financial institutions to ensure their clients don’t take on debt loads beyond their means. • The Bank of Canada recognizes that low interest rates are necessary to achieve its inflation target, but that they also present their own set of risks.