Global financial markets have fared well in May so far, fueled by economic data from the U.S. A weaker pace of job growth and slowing inflation numbers have rekindled hopes that the U.S. Federal Reserve may start cutting interest rates in the second half of this year. This week, we turn our attention to an important challenge facing many Canadian households: the meaningful rise in the cost of mortgages and rents.
Based on figures from a year ago, nearly 40% of Canadian households are renters and about 60% are homeowners. Of the latter, just over 50% have mortgages, while the remainder own their homes outright. Since the Bank of Canada began increasing its policy interest rate in 2022 (from a low of 0.25% to the current level of 5.00%), approximately half of Canadian mortgage holders have refinanced at higher rates. This has led to a significant uptick in mortgage interest costs, which have been rising by well over 20% year-over-year. While the rate of increase in mortgage costs has slowed modestly over the past number of months, it remains one of the biggest contributors to Canadian inflation.
According to the Bank of Canada’s recent annual Financial Stability Report (FSR), mortgage costs have driven the average mortgage debt service ratio sharply higher from a range of 10% to 15% over the past decade to a level now exceeding 20%. Mortgage holders are spending a larger portion of their income on servicing debt each month. Yet, the FSR report notes that households with mortgages have been managing the higher interest rate environment relatively well, with indicators of stress remaining below their historical averages. This resilience can be attributed to a combination of factors, including higher incomes, increased savings, reduced discretionary spending and healthy a labour market.
Nevertheless, the report suggests that many households with mortgages that originated in 2021 and early 2022 may face more intense financial pressure in the coming years. Home prices were near their peak then, and mortgages were initiated at the ultra-low rates available at the time. These homeowners may encounter financial strain due to much higher payments upon renewal, compounded by holding large mortgage values relative to their incomes, and equity in their homes that has either remained stable or decreased somewhat. Much of the impact of higher interest rates on mortgage holders may still lie ahead.
Renters in Canada may currently be showing the greatest signs of financial stress. The Bank of Canada report highlighted a steep increase in delinquencies on consumer debt, such as auto loans and credit cards, among borrowers without mortgages. The most recent inflation data from March indicated that the increase in rent prices has accelerated to a pace of more than 8% year-over-year, the highest in decades. Multiple factors continue to drive rent prices higher, including the higher cost of home ownership that has forced potential buyers to explore the rental market instead, low vacancy rates, and high immigration.
On a positive note, the Bank of Canada is nearing the point, potentially this summer, where it will begin to cut interest rates. This should provide some much-needed relief to Canadian households and may help to slow the increasing cost of home ownership and rent. Longer-term, the supply of housing needs to grow meaningfully to restore an appropriate balance between supply and demand. We will explore this issue in more detail in the months to come.
If you have any questions, please do not hesitate to contact us.