Monday Morning Interest Rate Update (November 5, 2012)

David Larock in Mortgages and Finance, Home Buying, Toronto Real Estate News

Mortgage Update Pic

Statistics Canada recently changed the way it calculates key economic data to
bring its methods into line with agreed upon international accounting standards.
As a result, the debt-to-income ratio for the average Canadian household shot up
11%, literally overnight, to 163% (a record high).

This has inspired lots of foreboding talk about how our “soaring” household
debt-to-income levels are now higher than U.S debt-to-income ratios were at the
peak of their housing bubble. That may be technically true, but it is also
totally misleading.

That’s because the standard method for calculating this ratio uses after-tax
income which isn’t a fair comparison because Canadian personal income taxes
cover health care costs and American personal income taxes don’t. (To put this
difference in perspective, according to my initial research the average American
spends anywhere from 10% to 20% of their after-tax income on health-care related

While it has become fashionable to predict that Canada is headed for a U.S.
style housing crash, most economists still think that is unlikely and they use
plenty of data to support their position. (Here is a post I wrote last year
called How
the US Lent Its Way to a Housing Bubble and Why It Didn’t Happen Here
if you
are interested in my detailed take on this question.)

To be clear, I readily agree that our household debt levels are too high and
that’s why I have consistently supported the federal government’s attempts to
reign in borrowing by changing the lending policies and regulations used by CMHC
and OSFI. But that’s a far cry from believing that our debt levels are about to
cause our houses to start spontaneously combusting. (Did I just give MacLean’s
an idea for their next apocalyptic magazine cover … or have they used that one

Before you start loading up on canned soup and fire extinguishers, consider
this sampling of recent comments from the experts I read:

  • A report done by BMO economists in January 2012, first pointed out the flaw
    in using after-tax income to compare Canadian and U.S. debt-to-income ratio
    levels. Instead, they argued that using a debt-to-gross income ratio would
    provide a better apples-to-apples comparison. Using this revised methodology,
    BMO economist Sal Guatieri reported last week that Canada’s debt-to-gross income
    ratio (121%) is still well below both the current (146%) and peak (166%) U.S.
    levels. That presents a very different comparison from the popular one being
    bandied about in much of the mainstream media.
  • David Rosenberg, a well-known Canadian economist, wrote last week that our
    ratio of housing starts to the civilian population is “not far off the average
    of the last ten years, whereas as in the U.S. back in the 2006-07 peak, that
    ratio was 25% above the long-run norm.” In other words, Canada has not seen the
    kind of short-term spike in speculative real-estate investing/borrowing that we
    saw in the U.S. during the latter stages of their housing bubble.
  • Mr. Rosenberg also notes that Canadian policy makers and regulators have
    been pro-active in responding to our rising household debt levels while their
    U.S counterparts were basically asleep at the switch until it was too late
    (hyperbole mine).
  • Further to that last point, Benjamin Tal, an economist with CIBC, recently
    noted in this video
    with Rob Carrick that overall Canadian household debt is now
    rising at its slowest pace in ten years, while consumer debt levels are actually
    falling for the first time in twenty years. That kind of momentum makes for a
    trend in the right direction.
  • In a separate report, Tal notes that the crash in U.S. house prices was far
    more extreme in cities with above average levels of sub-prime lending, where
    prices corrected by an average of 40%. This is more than double the average
    decline seen in U.S. cities with below average levels of subprime loans.
    “Eradicate subprime from the U.S. housing market and, instead of the most severe
    house price meltdown since the great depression, you get a soft landing.” By
    comparison, Canadian subprime loans account for about 7% of our total mortgage
    debt outstanding while U.S. subprime loans peaked at a little under 25% of their
    total mortgage debt outstanding before their housing crash.

Rate Sheet (Nov 5, 2012)Five-year Government of Canada (GoC) bond yields fell seven basis points for
the week, closing at 1.32% on Friday, and five-year fixed rates are still
available in the 3% range. Effective November 1, all OSFI regulated lenders will
now use the Bank of Canada’s Mortgage
Qualifying Rate
(MQR), which is 5.24% today, to qualify borrowers who are
applying for fixed-rate terms of less than five years. That said, those who know
where to look can still find well-established lenders who are not subject to
these new, more restrictive OSFI guidelines.

Variable-rate mortgages can still be found at discounts as low as prime minus
0.40% (which works out to 2.60% using today’s prime rate). Also effective
November 1, variable-rate borrowers who are putting down 20% or more are also
now subject to the MQR at OSFI regulated lenders. (Previously, only high-ratio
variable-rate borrowers were subject to the MQR.)

The bottom line: Like any informed observer who can see beyond his
own short-term self interest to what is best for the whole economy over the long
term, I am concerned about how ultra-low interest rates have pushed our
household debt levels to record highs. But I reject the implication that we have
driven over the debt cliff to financial ruin and are now in free fall just
waiting to hit the ground.

David Larock is an independent mortgage planner and industry insider specializing in helping clients purchase, refinance or renew their mortgages. David's posts appear weekly on this blog ( and on his own blog Email Dave

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