Those Who Bought Homes at Peak Prices Vulnerable to Debt, Becoming ‘House Poor’
Canadians drove up real estate prices in the last year as they went into a buying frenzy, deciding to make that first-time purchase, relocate, or upsize.
But one third of homeowners report feeling “house poor,” and nearly half are concerned that they won’t be able to make ends meet in the next year without going deeper into debt — the highest level in three years. Add into the mix the likelihood that interest rates will increase by 2022, and the fact that the rate of inflation is climbing. There are also expected tax increases, in light of government spending on COVID relief and other programs.
Buyers who purchased homes at the peak in the last year and who are also racking up other debts could be vulnerable, say industry experts.
Feeling “house poor” means one’s housing costs are taking up too much bandwidth. Three in 10, or 30%, say the pandemic made their debt level worse, as shown in a national survey compiled in June, by MNP Ltd., one of Canada’s largest accounting firms. The MNP Consumer Debt Index is a quarterly poll conducted by Ipsos for the firm.
But despite the worry, one-third of Canadians also plan to spend more than they usually would once they resume normal pre-pandemic life, such as travelling, going to concerts and eating out. And in BC, the plan to spend more –while also planning to live on credit to cover costs — is slightly higher than the national average. British Columbians, evidently, live for the day. MNP president Grant Bazian, who is based in Vancouver, says that aspect of the BC response stood out from the other provinces.
He said there are also signs that many first-time buyers entered into the market with uninsured mortgages, meaning they likely borrowed money from parents, or inherited money, to make big enough down payments. If they purchased at the peak in the last year, and there is a market correction, as well as a spike in rates, the concern is their ability to ride out the mortgage payment increases.
“If you are getting into a home on early inheritance or some other form of down payment, and you are thinking that low interest rates will continue on throughout the duration of the mortgage, I think there are going to be some surprises,” says Bazian.
MNP also help people who’ve taken on too much debt and become insolvent. The number of bankruptcy filings has dropped by at least 40% compared to pre-pandemic levels, says Bazian. But he expects that number to resume once the pandemic is over. He compares the situation to a tsunami. We are in the calm before the devastating wave rolls in. That calm is the illusion of security, created by government income and business supplements, rent increase freezes, and collection agencies and lenders giving people more time to repay debts. But those relief measures will soon end. And the Bank of Canada has indicated that the variable rate could go up late next year.
“What the tipping point will be for many varies,” says Bazian. “It depends what other debt they are carrying, what other circumstances are unfolding. And it depends how much interest rates go up.”
He said a half point won’t matter much, but a full percentage point can break some people. That’s why the Bank of Canada will likely slowly phase the rate up, making it a drawn-out process. But as the rate goes up, he expects to see more bankruptcy filings. Most people take on more work, find better paying work, or borrow money before they get to that point. But tens of thousands of people file for bankruptcy each year, simply because they didn’t know how to manage debt.
“I think it will be a bit of an awakening for some. I think most Canadians are in a good spot. But definitely the younger generation has not seen the double-digit interest rates [of the past], and they get a false sense of security. And they don’t have the savings, and they don’t have equity in a home that’s built up that they can rely upon.”
Mortgage broker Derek Christiansen, who’s been in the business for 18 years, says the saving grace is the federal government regulated stress test, which includes a qualifying rate of 5.25% or the rate offered by one’s lender, plus 2%, whichever is higher. It’s meant that buyers have had to settle for less home, or come up with a higher down payment, in order to qualify. The qualifying rate is regularly revised to ensure buyers don’t over leverage for the sake of home ownership. The new rate was set in June, the highest Christiansen has ever seen.
“As far as the affordability of the mortgage, that’s a substantial buffer — that’s like three and a half times the actual rate you have,” he says.
Until the stress test was introduced in 2018, a person would qualify at the actual rate they’d be paying, which was far more nerve wracking, he says.
“I think it’s brilliant. You will hear other mortgage brokers and realtors bitching about the stress test, that they should lower it. But I think it’s perfect, because most people can’t manage their funds that well, and most people are tempted to rack up more debt, whether it’s a Visa [card], or lines of credit on renovations or travelling or whatever, so the government needs to control that.”
That said, people could still go out and max out their credit cards and take on lines of credit, he adds.
Another group that could be at risk are the ones who have been buying up multiple properties as investments. He says a lot of mortgage brokers have seen that sort of activity in the last year, by people who are just average income earners, without a buffer. They could be in trouble.
“I’ve seen some people that have no business owning two or three properties stretching themselves to buy two or three properties. Some have done really well and made huge money. Others are in trouble if COVID happens again and the tenants decide they don’t want to pay the rent.”
As for the market itself, realtor Greg Carros of Engel & Völkers said that in a market like Vancouver, there’s enough wealth flowing that it would take a significant hike to have a big impact.
“In the sub-luxury and middle market, an interest rate hike back to 5 per cent will not make much of a difference,” he said. “If interest rates go up substantially, the market could soften a bit as buyers may wait it out and see what happens. Even so, there is a lot of wealth in Vancouver. The financial fall-out from COVID was less than expected, and we have noticed a lot of local interest in ultra-luxury properties.”