Homeowners are reducing their principal by $11 billion a year more than official estimates indicate
TORONTO, Oct. 15, 2014 /CNW/ - Canadians are paying down their mortgages at a record rate, significantly lowering the risk of default should interest rates rise, finds a new report from CIBC World Markets.
"Canadian households did not only resist the temptation of low rates, they used those low rates to pay down debt at a pace not seen before," says Benjamin Tal, Deputy Chief Economist, CIBC. "Despite a lethargic labour market and an unemployment rate that is still too high for the Bank of Canada's liking, debt service performance in Canada has almost never been better."
Homeowners are taking advantage of prolonged low interest rates to pay off their mortgages by accelerating their principal payments. In effect, they are voluntarily shortening their amortization periods. As a result, Mr. Tal estimates the average amortization period in the Canadian mortgage market is now closer to 20 years rather than the implicit assumption of 25 years the Bank of Canada uses in its calculations.
Indeed, instead of spending their disposable income, Canadians are making sacrifices, choosing to make extra payments on their mortgage to get out of debt faster. This ultimately makes Canada's mortgage market more stable because in the event of a rate hike, homeowners would simply return to their regular amortization period, he says.
"Canadian households are paying back an additional $11 billion a year in principal that's not being officially recognized," says Mr. Tal. "That extra cushion is sufficient to absorb the first 100 basis point increase in the effective mortgage rate, with households simply re-amortizing to offset the payment increase."
The report finds that the debt-service ratio in the Canadian mortgage market - the cost of carrying a mortgage as a share of disposable income - at the aggregate level is 7.3 per cent, a full percentage point higher than the current 6.3 per cent officially stated by the Bank of Canada.
Even in high ratio mortgages, the risk of default appears slim, says Mr. Tal. High ratio mortgages based on their loan-to-value (LTV) position reveals that very little has changed over the past few years, with the share of mortgages with LTV larger than 80 per cent in fact falling by five percentage points since 2009, he says. As well, the percentage of households allocating more than 40 per cent of their income to debt financing has remained relatively unchanged at just over 6 per cent since the 2008.
The report notes that the strongest predicator of mortgage default in Canada over the past six years has been a person's credit score. Here again, the picture is encouraging, says Mr. Tal.
The average credit score in Canada has trended upward over the past five years, with improvement seen in all regions and age groups, he says. Further, sub-prime credit - defined as those with a credit score of less than 620 - has remained virtually unchanged at close to 10 per cent of new accounts in recent years and is only 3.5 per cent of total new mortgages, he says.
"Canadian households deserve credit for not taking credit," he says. "But, it's not over yet. The Bank of Canada is determined to keep rates low for as long as possible - further testing the willpower of Canadians."
The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/eioct14.pdf
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SOURCE: CIBC World Markets
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