Mortgaged to the Hilt: Risks from the Distribution of Household Mortgage Debt

Abstract

The rising level of household debt in Canada has raised concerns that a future deleveraging could pose a threat to the economy. In this Commentary, we look behind the aggregate numbers on household mortgage debt to find pockets of vulnerability that raise warning flags. We focus on the distribution of household mortgage debt by income, age and region, which is of critical importance when gauging the risk from the increase in mortgage debt. Our analysis suggests that primary mortgage debt relative to after-tax income has increased, with a significant minority of Canadians having taken on a high degree of financial risk. The percent of mortgage indebted households with a primary mortgage debt-to-disposable income ratio in excess of 500 percent has climbed from 3 percent in 1999 to 11 percent in 2012. That is far from the majority of Canadians, but it does represent half a million households. We find the increase in highly mortgage-indebted households has been in all income groups, but more so in lower-income quintiles. The increase in financial risk is also evident across all age groups, but more so for younger Canadians who have entered the market most recently. As one might expect, there has been greater concentration of mortgage debt in the provinces with the strongest housing booms. When an evaluation is made of mortgage debt relative to accessible financial assets, most Canadians look secure. But, there is a significant minority at risk. Roughly 1-in-5 of mortgage indebted households have less than $5,000 in financial assets to draw upon in response to a loss of income or to higher debt service costs. 1-in-10 mortgage-indebted households have less than $1,500 in financial assets to address any shock. This represents an inadequate financial buffer, as the Statistics Canada Survey of Household Spending indicates that average mortgage payments are more than $1,000 a month, before taxes and operating costs. The data suggest that the majority of Canadians have been responsible in their borrowing, but the sustained low interest-rate environment has encouraged a significant minority to take on considerably more mortgage debt relative to after-tax income. And, it is evident that there are particular pockets of excessive leverage or risk. Beyond risks related to mortgage default, higher debt-to-disposable income ratios can pose economic risks as higher ratios have been associated internationally with larger falls in consumption during difficult economic times. The federal government may want to consider further policy actions to lean against the shift towards significantly higher mortgage burdens. However, such policy measures should not be unduly heavy handed and should be targeted to address the distributional nature of the risks.