Friday, December 16, 2011

Keeping debt to income ratios in perspective

By Mark Kerzner
President, TMG The Mortgage Group

While there have been multiple rounds of credit tightening in the last few years and countless comparisons to the U.S. housing meltdown, it’s important to also look at the underlying health of our lending and credit markets.

This is especially relevant in light of recent news articles again indicating that the amount of household debt is “triggering alarms” (http://www.theglobeandmail.com/globe-investor/personal-finance/household-finances/record-high-household-debt-in-canada-triggers-alarm/article2269210/). While it’s true that our debt to income ratios are at record levels (>150%), it’s also important to keep perspective.

Let’s look at the facts:

  1. Serious delinquency rate in Canada is approximately 0.4% versus 4.1% in the U.S. according to economist Benjamin Tal
  2. Currently 1.1% of Canadian houses are experiencing negative equity versus approximately 22% in the U.S. (Benjamin Tal)
  3. Even though 22% of Canadian mortgages have amortizations greater than 25 years, 36% of all mortgage holders made voluntary supplemental payments in 2011 (CAAMP Fall survey)
  4. While total debt (mortgages, lines of credit, credit cards, etc) to income ratios in Canada have hit 150%, average mortgage interest rates this past year were 3.92% (30 basis points below a year earlier.
  5. The most common use for funds taken from equity take-outs (refinances) in the past year is debt consolidation and repayment which reduces other forms of debt. Contrary to the concerns of some, by using a mortgage as a debt consolidation tool, total servicing debt costs are often reduced. This gives clients a potential strategy for reducing their total outstanding debt by using excess cash flow to more aggressively pay down that debt.
  6. The Government has established a benchmark for qualifying mortgage customers at higher rates if they are taking an Adjustable Rate or a Term less than 5 years. On average that benchmark rate (average 5.38% in 2011) has been 1.46 points higher than the 5-year discounted rates and 238 bps higher than PRIME, which is currently at 3%.  This means clients who have chosen ARMs or terms less than 5 years have built in some buffer in the event interest rates do rise prior to renewal or during the term.
It is widely expected that during the course of present term mortgages, rates are likely to increase prior to renewal dates. Keep in mind that if interest rates rise, it is often correlated to a stronger economy. With a stronger economy comes improved employment levels and earnings.

While many are predicting an eventual increase in interest rates the current consensus based on Canadian economic forecasts and the European economic crisis is that rates are likely to stay low here in Canada for some time.  That is the dilemma. What is needed is more spending and less saving but not via increased credit which is difficult to achieve. The bank will have to run the risk that credit growth will continue so long as interest rates stay at these low levels.

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