Can Canadians Take a Hike?

On June 13, Manulife Bank published the results of its "Debt Survey". The study polled 2,001 Canadians across all provinces with household incomes over $40,000. According to Manulife’s summary of the results: “Nearly one in four homeowners would have to sell home if interest rates rise more”. This was picked up by several Canadian news outlets. At first glance, this seems a little sensationalist so let’s dig into the numbers to determine if the alarm bells are justified.

In the survey, completed before the Bank of Canada’s latest 0.50% interest rate hike, 20% of homeowners state that rising interests will have a “significant negative impact” on their financial situation. However, what qualifies as a significant negative impact? Nearly half of those surveyed would struggle to handle unexpected expenses or are reconsidering summer vacation plans due to affordability concerns. It could be argued that “significant negative impact” and “reconsidering summer vacation” don’t exactly align. Perhaps we have become accustomed to this financially accommodative environment.

Using published data by the CMHC (Canadian Mortgage and Housing Corporation) and assuming a 25-year amortization, we can begin to see how the average Canadian will be affected. The main metric we will focus on is the Gross Debt to Service Ratio (GDSR). This tracks how much of a household’s monthly income will be used to service their debt. The general limit is 39% (including property taxes and heat). Note, that this number does not include credit card debt payments and other debt obligations, which are included in the Total Debt Service Ratio (TDSR).

Scenario 1: The Average Joe & Jane

• Average Canadian new mortgage value in 2021: $354,406*

• Assuming a 25-year amortization period

• Average Canadian Household Income 2020: $122,100** 

In scenario one, we can see that even if you were lucky enough to snag a 1.50% variable rate mortgage, even if interest rates were to climb to 5%, you would still be below the 39% GDSR threshold. That being said, the negative impacts of an additional $1,000 a month may be felt.

Scenario 2: Joe and Jane Move to Vancouver

• The metropolitan area with the most expensive new mortgage value in 2021, Vancouver: $556,205

• Assuming a 25-year amortization period

• Vancouver Average Canadian Household Income: $130,400** 

In this scenario, we can begin to see which mortgage holders are feeling the effect of rising rates. Again, using our 39% GDSR cap we can see that the average person who obtained a mortgage in Vancouver in 2021, will struggle if their variable rate approaches 5%. For context, currently, we are seeing approximately 3% offered on the new 5-year variable mortgages and a strong possibility of a 0.75% interest rate hike at the next Bank of Canada meeting.

 Scenario 3: Joe and Jane cannot afford to live in Vancouver anymore

• The metropolitan area with the least expensive new mortgage value in 2021, Trois-Rivières: $140,912*

• Assuming a 25-year amortization period

• Trois-Rivières Average Canadian Household Income: $100,900**

In the third scenario, the average household should be more than comfortable covering the average mortgage payments in Trois-Rivières, Quebec.

Using this breakdown, it becomes more apparent which Canadians may be reconsidering their summer vacation plans. Homeowners in more expensive metropolitan areas appear to be most at risk. Although we do not have the breakdown of the residential area from the Manulife Survey, the survey did state that “as many as 18% of homeowners believe that they can no longer afford the house they own”.

Evaluating a bleaker scenario, the average Canadian residential property sold in April 2022 was $746,000. If a mortgage was obtained with a 10% down payment using CMHC insurance, a household will begin approaching the 39% GDSR marker if their mortgage rate rises above 3%. In Q2 2021. 25% of the 493,000 mortgages issued by chartered banks were insured.

Scenario 4: Feeling the pinch

• Average Canadian residential property sold in April 2022 with a 10% down payment: 671,400***

• Assuming a 25-year term

• Average Canadian Household Income 2020: $122,100** 

Despite the alarmist headline stating that one in four Canadians would have to sell their homes with rising rates, the average Canadian is equipped to continue to make their mortgage payments. Nevertheless, it is very plausible to see that rising rates coupled with record inflation will leave one in five Canadians no longer feeling confident in their financial situation. With inflation showing no signs of slowing down, the Bank of Canada finds itself in an increasingly difficult position.

*Source: CMCH Average Value of New Mortgage Loans

**Source: CMCH, Real Average Household Income Before Taxes

*** Canadian Real Estate Association