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More on Canada's Housing Bubble and Debt Levels

Wednesday, September 1, 2010 21:52

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Read more at Canada’s Housing Bubble

Personal Debt in Canada: The Ticking Time Bomb

As we celebrate Team Canada’s men’s and women’s gold medals in hockey at the Vancouver 2010 Olympics, we are all feeling good. Our country is back on top of the hockey world, and things are looking up. While we may be feeling good about our hockey teams, we aren’t feeling as good financially. Why? 2009 was a record year for personal bankruptcy filings in Canada, and the causes of the spike in bankruptcies have not gone away. The economy remains weak, and we are still carrying record levels of personal debt. That’s our biggest financial problem: debt. Debt continues to grow, and, like a ticking time bomb, high debt levels get us closer to the point of no return.

Despite the recession, or perhaps because of it, Canadians continue to borrow at record levels. By the end of the third quarter of 2009 the average Canadian adult had over $40,000 in household credit, a record level. Household credit includes credit cards, bank loans, and mortgages, so $40,000 may not appear to be a large number. After all, many people have mortgages of greater than $40,000. That’s true, but many other Canadians don’t have any mortgages or debt, so to average $40,000 over all adult Canadians, many of us are obviously carrying a significant amount of debt. As the chart shows, back in the year 2000 we each had approximately $20,000 in debt, so in less than a decade the debt we are carrying has doubled.

That’s a staggering statistic. If you are the average Canadian, your debt has doubled. Has your income doubled? Are you making twice as much today as you were earning in the year 2000? Probably not. If you still have a job you may have received “cost of living” increases of 2% per year for the last decade, but that obviously does not add up to a doubling of your income.

With these massive levels of debt, why hasn’t everyone gone bankrupt in Canada? Part of the reason is that interest rates have remained low.

In fact, mortgage rates, and consumer loan rates are lower today than they were three years ago. Low rates are partially due to governments around the world deliberately keeping rates low to stimulate spending, but low rates are also the result of the recession, where fewer people are borrowing to buy new houses, cars, and other goods.

Of course debt alone is not a problem. If I have a million dollar mortgage, but I have a job that pays me $2 million per year, my large mortgage is not really a problem. However, even if I have a small $50,000 mortgage, if I’m not working I won’t be able to make my mortgage payments on even a small mortgage. The key here is serviceability: your ability to service the debt you have.

Our ability to service our debt is a combination of the amount of debt we have (which is high), the interest rates we are paying (which are low today on most forms of debt), and our income (which for many Canadians has decreased during the recession). As the chart shows, our household debt as a percentage of our personal disposable income continues to rise.

In fact, by the end of the end of September 2009 (the most recent numbers available), the average Canadian adult was carrying household debt of 140.8% of their personal disposable income. That’s the highest level in history. Three years ago that level was “only” 120%. Stated another way, for every dollar you earn, you have $1.41 in debt, if you are the average Canadian. Obviously during this recession our debt has increased much faster than our income, and Canadians are spending more of each dollar they earn servicing their debts.

If you have a good job, and if interest rates stay low, you will probably be able to continue to service your debts. But the numbers prove that we are standing on the edge of a cliff, and all it will take is a slight breeze to knock us over the edge.

Ask yourself this: if you were to lose your job, or have your hours cut back at work, or go through a divorce, or have a medical problem so you couldn’t work, would you be able to continue paying your mortgage, your car loan, your line of credit, and your credit cards? For most people, the answer is “no”.

So what can you do to protect yourself?

First realize that your situation is precarious. Unless you have a very secure job, be very careful taking on new debt. Now may not be the time to buy a bigger house, or a new car.

Second, take steps now to reduce your expenses. You probably don’t control your paycheque, but you can control your expenses. Think about moving to a smaller house or apartment to save money. Trading in your car for something with a lower monthly payment, and a vehicle that’s better on gas, may be a good idea. Review all of your other expenses: do you really need 500 channels on T.V.that you never watch? Do you need to buy your coffee each day at the coffee shop, or can you learn to make your own? If you reduce your expenses, you will have more money to use to pay down your debts.

Finally, take steps to reduce your debt. Sell your second car and pay off the loan. Put a freeze on new spending, and start paying down your debt. Don’t just pay the minimum monthly payment on your credit cards; actively work to pay them off completely. If you can pay off your debts while you are still working, you will be in a much better position to weather the storm if you do get laid off, or if your hours are cut.

Average Canadian household debt reaches $96,000

The average Canadian family’s household debt rose to $96,000 last year, a new study says.

Debt-to-income levels rose to 145 per cent – the highest level ever recorded in the study, which has run annually for 11 years.

The Vanier Institute of the Family study found a dramatic rise in late debt payments.

Mortgage payments that were at least 90 days late were up 50 per cent over 2008.

Additionally, there was a rise of 40 per cent in credit card payments that were three months behind.

The study said first-time mortgage buyers were taking on the most debt, unsurprisingly. However, the study says that many have taken advantage of record low interest rates and may have problems making payments if interest rates rise.

Two-thirds of Canadians 18-34 would find themselves in trouble if their paycheque was delayed by only one week, a September 2009 survey by the Canadian Payroll Association found.

However, the study also found Canadians were saving more since the recession began.

The personal savings rate rose from about 2 per cent to nearly five per cent in the last four quarters, the study reports.

“This is a huge shift in attitude and behaviour by households,” the study says.

On Tuesday, Finance Minister Jim Flaherty introduced tighter mortgage regulations for Canadians, in part out of concerns about rising debt levels.

Housing prices due to fall, says think-tank

Canada’s major metropolitan housing markets are looking awfully bubbly and are due to burst, says a report released Tuesday.

The report, entitled Canada’s Housing Bubble: An Accident Waiting to Happen, by the Canadian Centre for Policy Alternatives, looks at prices in Toronto, Vancouver, Calgary, Edmonton, Montreal and Ottawa.

It concludes that housing price appreciation is frothy in comparison to historic values.

“I think at best you will see stagnation in housing prices or some kind of correction, and at worst you will see the bubble bursting,” said David Macdonald, an economist and research associate at the centre.

Housing bubbles emerge when prices increase more rapidly than inflation, household incomes and economic growth. That has been the case for Canada over the last run-up in prices, according to the report.

Macdonald said this bubble is different than others, because for the first time it is spreading beyond Toronto and Vancouver.

“Canada is experiencing for the first time in 30 years a synchronized housing bubble across the six largest residential markets,” he said.

Major banks have reached conclusions similar to those of the left-of-centre think tank. The Toronto Dominion Bank has estimated that average prices are 10 to 15 per cent too high, while the CIBC has said prices are 14 per cent overvalued.

Canada has only had three bubbles. Toronto experienced a large bubble in 1989, while Vancouver had two burst in 1981 and 1994.

Macdonald said a full-blown crash can still be avoided if mortgage rates do not ratchet up quickly and if government puts more stringent requirements on lending.

He said legislation could be introduced to return mortgage lending to 2006 criteria, where purchasers had to put 10 per cent down for a 25-year amortization. Although the federal government already put tighter restrictions in place earlier this year, buyers still have the option of putting 5 per cent down and can take a 35-year amortization on homes.

“Consumers should also play a part by not buying more house than they can afford,” says Macdonald.

The report says the last bubbles were triggered by interest rates moving up by just one per cent above the two-year rolling average.

“It doesn’t take much for consumers to take pause, especially those who are used to seeing such low rates,” said Macdonald. “You also have a lot of consumers, particularly outside Toronto and Vancouver, who have no memory of what a bubble is like or the aftermath.”

Low mortgage rates, access to easy credit and net immigration have also contributed to price pressures, said Macdonald.

Between 1980 to 2000, the historical price range for housing stood at between $50,000 and $80,000 in inflation-adjusted 1980 dollars. But within a brief five-year period from 2001 to 2006, major housing markets shot to well above that $80,000 average, according to the report.

“The comfort level isn’t there as affordability erodes,” said Macdonald.

Housing prices have stayed in a narrow range of 3 to 4 times income in the 20 years before 2000. The problem is, says Macdonald, is that housing prices adjusted for income today are anywhere from 4.7 to 11.3 times annual income in the six major areas.

Not everyone agrees with the findings of the report.

Toronto economist Will Dunning says that the market cycle is in a cyclical downturn – not a bubble.

“It is quite possible that the next phase of the cycle will be a partial reversal of the price gains of maybe 5 to 10 per cent, but this is not a post bubble collapse,” says Dunning.

“It is the operation of a functioning market in which the vast majority of buyers are making decisions based on their real needs, not the mindset normally associated with bubbles.”

Despite their differences, all analysts seem to agree that prices could fall.

Macdonald gives three scenarios in which prices might drop. The first is similar to what happened in Vancouver in 1994, a market correction through price deflation.

In that scenario, Toronto prices would decline by 9 per cent from an average of $420,000 to $382,000.

In the second scenario, the bubble would burst more slowly, similar to the 1989 Toronto bubble. In that case, prices would decline by 21 per cent from $420,000 to $330,000 over a five-year period.

In the worst scenario, a bubble would form similar to the United States and prices would fall rapidly. In that case Toronto prices would drop 20 per cent over three years to $335,000. The price drop would be slightly less than in scenario two, but happen more rapidly.

“Bringing house prices down just enough to moderate expectations but not so much as to cause a panic is a delicate balance,” says the report.

“Government policy makers, the Bank of Canada, as well as rate setters at the big banks need to work together to steer the Canadian market to a soft landing. The alternative is not acceptable.”

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