Recent figures highlight that nearly 40% of Canadian households are renters, with just over 60% owning homes. Among homeowners, slightly more than half carry mortgages, while the rest own their properties outright. Since the Bank of Canada initiated rate hikes in 2022, escalating their policy rate from a low of 0.25% to a peak of 5.00%, about half of mortgage holders have refinanced at these elevated rates. Consequently, mortgage interest costs have surged by over 20% year-over-year, contributing notably to Canadian inflation. Although the rate of increase in mortgage costs has decelerated recently, it remains a significant contributor to inflation.
The Bank of Canada’s latest Financial Stability Report (FSR) reveals that the average mortgage debt service ratio has escalated from a historical range of 10-15% to over 20% today. This indicates that mortgage holders are allocating a larger portion of their income to debt servicing. Despite this, households with mortgages have managed the high-interest environment well, with stress indicators remaining below historical averages. This resilience is attributed to higher incomes, increased savings, and reduced discretionary spending.
Future Challenges for Recent Mortgage Holders
Nevertheless, the FSR warns that homeowners who secured mortgages in 2021 and early 2022 might face significant financial pressure in the coming years. These mortgages were taken out when home prices were peaking and interest rates were at historic lows. As these homeowners renew their mortgages at much higher rates, they could experience financial strain due to larger payments, high mortgage values relative to their incomes, and potentially decreased home equity. Thus, the most severe impact of higher interest rates on mortgage holders may still be forthcoming.
The Plight of Renters
Conversely, renters in Canada are currently experiencing the greatest financial stress. A Bank of Canada report notes a sharp rise in delinquencies on consumer debt among non-mortgage borrowers, including auto loans and credit cards. March’s inflation data indicated an accelerated increase in rent prices, surging over 8% year-over-year, the highest in decades. This rise is driven by several factors: the higher cost of homeownership pushing potential buyers into the rental market, low vacancy rates, and high immigration levels.
A Glimmer of Hope
Looking ahead, there is some optimism as the Bank of Canada is nearing the point where it may begin cutting interest rates, potentially as soon as this summer. At this moment, the cracks in consumer strength and slowing of the Canadian economy is viewed as a “positive” development if one hopes for rate cuts. Below we highlight the two most important considerations for any Central Bank - jobs and inflation. With the labour market showing signs of slowing and with inflation on track to hitting the Bank of Canada’s target, this data could provide the green light for a rate cut as early as June. Such a move could provide a much-needed relief to Canadian households, potentially slowing the rising costs of homeownership and rent. In the longer term, addressing the housing supply shortage is crucial to restoring balance between supply and demand.
For sophisticated investors, these dynamics present both challenges and opportunities. Understanding the evolving landscape of mortgage and rent costs is essential for making informed decisions in the Canadian housing market. As always, a strategic approach that considers both current trends and future projections will be key to navigating these complex conditions.