Household Debt Worries Canadian Banks

by admin on February 24, 2011

In recent months, banks have been issuing warnings about the increasing household debt of Canadian families, which reached unprecedented heights (Winnipeg Free Press). It is true that the rate of increase slowed a bit in 2010; however, leading bankers, such as Bank of Canada’s governor Mark Carney, fear that in the event of a spike in the interest rate, many Canadians will go under, unable to keep pace with their monetary obligations.

Although it has been increased three times since June, the Bank of Canada’s lending rate is currently sitting at a relatively low level. The interest rates of the banks, which are contingent on the central bank’s rate, are expected to remain low. This is good news for Canadian companies and entrepreneurs because it will allow them to borrow at better terms the money they need to operate. However, it is not only the corporate entities which benefit from this cheap money – low interest rates also encourage consumers to take loans, which, by the way, is the reason why the real estate market has been in such a good condition.

Unlike many borrowers in the United States, who had to pay down their credit card debts, Canadians remained relatively protected during the global economic crisis. As a result of that, purchasing with a credit card continues to be very popular here. Some cards go with outrageously high interest rates but people don’t seem to pay attention to ‘details’. On top of this, there is an increasing number of Canadians who borrow against their home equity. Experts are ringing alarms that these tendencies may lead Canadians away from ‘good’ debts, such as mortgages, and into ‘bad’ debts, i.e. loans taken to procure luxury goods, such as yachts, state-of-the-art cars, and RVs.

The government does not have at its disposal many means to decrease the growing household debt of families in Canada. One of its few levers for regulation, however, remains the Canadian Mortgage and Housing Corporation. And the government did well when it abrogated the zero-down payment mortgages which the Corporation was giving in 2008.  In addition, the initial deposit was increased to five per cent for individuals who wanted mortgage insurance through the Canadian Mortgage and Housing Corporation. This year, the government of Prime Minister Stephen Harper made it even more difficult for people to receive the insurance. However, it refused to comply with the recommendations of some bankers for even stricter measures (e.g. bigger down payments and a new curtailing of the amortization period).

On Monday, 13th December, PM Harper and Finance Minister Jim Flaherty promised they would reconsider the bankers’ proposals, but stressed that it is primarily up to the Canadian consumers themselves to limit the amount of their household debt (Winnipeg Free Press). And here they have a good point. The debt analyses issued lately should serve Canadians as a wake-up call and make us realize how easy it is to overspend and begin to live beyond our means. After all, everyone likes to feel at least like an upper-middle class fellow, but only some people are.

A different question is whether the government should follow the suggestions of people like Mr. Carney and intervene once again to protect CMHC. It may seem too drastic to bump up the down payment rate anew, with negative effects on the real estate market. However, if this is what the bankers recommend, PM Harper and the Cabinet may as well pay attention and go with the recommendations.

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