Canada's Housing Bubble

Mar 30, 2010 Sunny Freeman The Canadian Press

Toronto - One in five Canadian homeowners struggling to keep a roof over their heads have to make drastic cuts to even the basics, and that number could soon balloon as the costs of home ownership increase, experts say.

Mortgage rates are marching higher after a period of historic lows, rock-bottom rates that allowed many Canadians into the market who might not otherwise have been able to afford a home, with some taking on dangerously high debt.

Unaffordable housing, defined as that which consumes over 30 per cent of owners' pre-tax income, causes owners to reduce spending in other areas, which can have negative health effects, the Conference Board of Canada said Tuesday.

"About one-fifth of Canadian households do not have the resources to afford both good-quality homes and other health-enhancing expenditures, such as nutritious food or access to recreational activities," said Diana MacKay, the Conference Board's director of education and health.

The associated health issues can spill over into the economy at large, the research group said, reducing productivity, limiting national competitiveness and indirectly driving up the cost of health care and welfare.

The board added that about 25 per cent of Canadian households already rely on housing subsidies or experience periods of housing "unaffordability," a figure it expects to increase.

Among those likely to suffer as rates rise are new homebuyers who pushed their finances to the limit to get into a house. They may soon find it difficult to pay for their purchases, said University of Winnipeg professor Tom Carter, the Canada research chair in Urban Change and Adaptation.

"There's a lot of people who didn't have to put very much down," Carter said.

"Mortgage rate lending has been fairly flexible in recent years but they still have very high mortgages and when the rates go up, we are going to have more people with a serious affordability problem."

Economists have been warning for weeks that rising mortgage rates were on their way and by Tuesday six of Canada's largest banks had raised some rates by more than half a point.

Finance Minister Jim Flaherty announced new mortgage qualification rules last month to discourage homeowners from taking out mortgages on homes they might not be able to afford down the road when rates return to more normal levels.

To qualify for an insured mortgage, borrowers will have to meet the standards for a five-year, fixed-rate mortgage even if the period they choose is shorter and the interest rate they pay is lower.

But Ian Lee, MBA director at the Sprott School of Business at Carleton University in Ottawa says he tried to push Flaherty to go even further. He wanted the government to increase the down payment required to purchase a home from five to ten per cent, restricting ownership to those with higher incomes.

"Anybody that's poor, meaning can't afford it, they can't get a mortgage any more, so you just shut them out of the market."

Lee said the problem isn't home affordability per se, but a societal emphasis put on home ownership, which some people simply can't afford.

"If you can't afford the bills and you can't afford the payment and you can't afford the municipal (tax) payment, then you don't have the right to own a home," he said.

He added that while mortgage rate increases could make the debt loads for overextended owners' unbearable, Canada is not likely to see a foreclosure crisis similar to the one U.S. consumers faced in the wake of the sub-prime mortgage crisis south of the border.

Carter said there could be more defaults on loans and more home foreclosures in the coming year, but added most people will scrimp on other spending to pay off their mortgages or rents.

"If people really have to cut back in other areas to make their housing payments, it's going to affect consumer spending overall," he said.

Meanwhile, a study released Tuesday found that 65 per cent of Canadians reported they were doing more saving than spending due to large personal debt.

And more than one-third are so loaded down with non-mortgage debt that will take three years or more to pay off, according to the Consumerology report released Tuesday, commissioned by Toronto-based advertising agency Bensimon Byrne.

Queen's University business professor Louis Gagnon said the rise in interest rates means borrowers should put themselves in risk-management mode.

"Interest rates have nowhere to go but up, which may have a big impact on mortgage payments when people renew," Gagnon said. "The best way to prepare for the future is to pay our debt, not go further into it. In these uncertain times, leverage is out and deleveraging is in."

Adrian Mastracci, a portfolio manager at KCM Wealth Management, said debt-burdened consumers should consider consolidation while they can still lock in to relatively low rates. Borrowers with mortgages at higher rates don't need to wait until their loan matures to renegotiate, as most loans have prepayment privileges.

He said consumers should aggressively pay down lines of credit now so their monthly interest costs don't rise when rates do, while those with high credit card balances should transfer them to a lower cost line of credit or mortgage.

He advised shopping around because lenders will negotiate to attract or keep business, adding it's important to borrow only what is required and to design a plan to repay it in the shortest time.