Globe Editorial: Warning: Canadians are house rich — but deeply in debt

Canadians have a lot of debt – and the Canadian banking regulator is worried. It must be.

Of particular concern is the so-called rehabilitable mortgage. This debt combines a regular mortgage and a home equity line of credit. As the mortgage principal is paid off, the line of credit can increase—which can lead to a situation of permanent debt. That’s pretty much how the Bank of Montreal promotes it: “Borrow some. Pay off some. Borrow again. Pay off your mortgage. Borrow more.”

“Borrow more.” This was the story of the past two years. At the end of March, pooled line of credit loans for home mortgages totaled $737 billion — an increase of a third since the start of the pandemic. The jump led the Office of the Superintendent of Financial Institutions to consider tightening the rules. OSFI has warned of the potential for “weaknesses” in the Canadian banking system and suggested that they could lead banks to consider changeover mortgages more risky than is currently required. This would make it more expensive for banks to offer to customers, and ease their use.

OSFI’s deliberations come at a time when there is an astonishing mix of good and bad news in the financial health of Canadian households.

There is a lot of wealth, but there is also a lot of debt. Canadians have a large pile of savings, accumulated during the pandemic, and unemployment is low. But inflation is high and interest rates are rising.

Behind it all lies Canadians’ dangerous love affair with housing.

Statistics Canada reports that household net wealth reached a record $15.9 trillion at the end of 2021 – 20 per cent higher than $13 trillion in mid-2020. The main driver was turbocharged real estate.

In the same report, Statscan also looked at the other side of the ledger – debt. At the end of 2021, the ratio of household debt to their disposable income reached a record high of 186.2 percent.

This number means that families owe $1.86 for every $1 of their disposable income. A decade ago, it was $1.68 and the previous peak was $1.85 in summer 2018. This number places Canadians among the most indebted countries in the world, ninth in the Organization for Economic Co-operation and Development, and outperforming people in the United States.

Like OSFI, the Bank of Canada viewed all this with caution – and was concerned about how financially stressed Canadians could one day become a risk to the broader economy. “High debt levels mean the economy may react particularly poorly to certain types of shocks,” Bank of Canada Deputy Governor Paul Beaudry said last November. Potential shocks with painful feedback loops include job losses, lower housing prices, and higher interest rates.

The precarious housing situation in Canada, and all that debt, was a topic the central bank returned to in mid-May. The bank is in the process of raising interest rates, but it has to keep a close eye on what higher interest rates do for debt-laden homeowners. To rein in inflation, the bank wants to cool the economy down a bit – a calculated click on the brakes – but high debt levels mean every interest rate increase could be hit hard. Uncertainty about the impact of all that debt can make things difficult for the bank.

“This slowdown may be amplified this time around because highly indebted households will face high debt servicing costs and are likely to cut spending more than they would otherwise,” said Tony Gravel, deputy governor of the Bank, in a recent speech. One of the flashing numbers Mr Gravelle referred to was the debt-to-income ratio of 186 per cent.

What it all adds up to is a huge note of caution.

For years, Canadians have been fed on ever-higher real estate prices. Home ownership lines of credit, including rehabilitable mortgages, are common, and they’re an easy way to pull money off the cash register for high home prices. These loans can be useful, whether to pay for renovations, vacations, or even investments in other real estate. When your home is worth $2 million and going up, what’s the problem?

If home prices continue to rise forever, there will be fewer worries.

But with housing market levels rising and interest rates rising, a chill is likely. It would also be quite desirable – if the debt was not too high. Obviously, OSFI considers the stricter rules around equity lines of credit prudent. And it was long overdue.

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