I recently read an article in the National Post titled "Canadians are just $200 away from being overwhelmed by debt, new survey finds."
The study conducted by MNP found that 31 per cent of Canadians they surveyed are not paying their bills on time.
I find that number disturbingly high and am even more disturbed by the fact that this is happening at a time when interest rates are at historical lows.
What really grabbed my attention was the last paragraph of the article which was a quote from Grant Bazian, president at MNP Debt. Mr. Bazian said "With so many already feeling unable to cover their bills and debts, there is tremendous vulnerability to any kind of economic shock -- the loss of a job, an emergency, a divorce, even things like a reduction in overtime pay or bonuses -- and especially in interest rates."
Two things have happened since that article was published:
- On Monday October 3rd the federal government announced it was introducing a series of changes including what Finance Minister Bill Morneau referred to as "more stringent 'stress testing' for borrowers who take out insured mortgages and rules aimed at mortgages with higher down payments".
- On Wednesday October 5th the International Monetary Fund reported that world debt hit a record 152 trillion. That equates to more than two times the size of the global economy.
The world is seriously addicted to debt and there seems to be no slowing down the appetite for credit. Central banks around the globe continue to print seemingly limitless amounts of money which is finding its way into both corporate and personal hands.
Notwithstanding what may happen to companies when the interest rates start to rise, my concern is what's going to happen to individual Canadians. While the federal government is trying to rein in some of the borrowing that's taking place by making it more difficult to borrow, every one of us should take heed -- interest rates will rise.
I believe the most important thing individuals should be doing is locking in their mortgages (ideally for five years). Rates on five-year fixed rates are as low at 2.45 per cent. The purpose for locking in your mortgage is to eliminate exposure to interest rate increases over the next five years.
If your mortgage has renewed recently or you've had a discussion with your banker recently they've probably told you to go with a floating rate mortgage. They'll show that over that last 10 years (sometimes more) people with floating rate mortgages have done better than those with fixed rate mortgages. It's true, they have but what they don't usually go out of their way to show is that this result is due to the fact that over the last 10 years interest rates have been on a steady trend down. Between 2007 - 2016 the central bank rate has come down from 4.5 per cent to 0.75 per cent; the prime bank lending rate has come down from 6.0 per cent to 2.7 per cent; and the five-year fixed mortgage rate (posted) has come down from 6.65 per cent to 4.64 per cent.
I know it's temping when you're shown the mortgage rate on a five-year floating rate mortgage is prime - 0.75 per cent making the current rate 1.95 per cent (2.70 per cent - .75 per cent), but don't be fooled. It's only temporary. Banks don't have to wait for interest rates to rise to change their own rates. Nor do they have to move in lock-step with the Bank of Canada (BOC). There have been a number of occasions over the last 10 years where the BOC has reduced the overnight lending rate they charge the chartered banks only to see the chartered banks reduce the rate they charge customers a fraction of the reduction the banks themselves received.
"Banks don't have to wait for interest rates to rise to change their own rates."
It's also not unusual to see the banks move rates up in anticipation of rate increases by the BOC. With a floating rate mortgage you're at the mercy of the bank. Now is the time to take the risk of an interest rate increase out of the equation.
If you have a floating rate mortgage you assume the risk of an interest rate rise. If your mortgage is fixed, the bank assumes the risk of an interest rate rise. Who do you think is in a better position to assume that risk?
You may not have control over losing your job, an emergency, a divorce or even a reduction in pay, but you can control your mortgage -- lock in your mortgage now before the deal of a lifetime is gone.
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Also on HuffPost:
Finance Minister Bill Morneau's new mortgage rules, enacted in October, 2016, could "reduce the risk of a knock-on to the Canadian economy" from any possible corrections in Toronto or Vancouver, BMO economist Sal Guatieri told The Financial Post. The Bank of Canada has long warned that interest rates could go up again — and Canadians should ensure they can still afford to pay. Now they have to prove it to lenders.
First-time homebuyers tend to be the "primary users of mortgage insurance," according to Royal Bank of Canada. So the "stress test" could make it difficult for them to borrow as much as they'd like to. In a way that's a good thing. It means they can only borrow what they can afford. But it also means they won't have as much purchasing power in a hot market. That said, the new rules are probably protecting them from a debt burden they can't handle.
Home sales could fall as much as eight per cent in the first year after the new mortgage rules come into effect, Bloomberg reported. Of course, that depends on what buyers do. They may decide not to buy homes at all, they could also opt to buy cheaper properties, or dig into their savings just to afford their purchases, finance department spokesman Jack Aubry told the news agency. Meanwhile, the Bank of Canada says home sales could fall by as much as 10 per cent, while prices could drop by five per cent.
Stricter mortgage rules could mean that borrowers start turning to "shadow-banking," according to Canaccord Genuity. "Shadow-banking" refers to activities that happen outside traditional financial institutions. While bigger banks lend money using cash from deposits, shadow banks use money from groups of investors and aren't subject to the same scrutiny as major financial firms. They could therefore be more likely to hand out bad loans.
Canada's economy as a whole grew by $4.2 billion from the fourth quarter of 2014 to the second quarter of 2016, according to Macquarie Research. But residential investment increased by 3.5 times that amount ($14.7 billion) in the same time frame as housing activity skyrocketed in Vancouver and Toronto. Watch for residential investment to decline.
There are concerns that the new rules don't create an even playing-field for mortgage lenders outside the big banks, The Globe and Mail reported. Alternative lenders such as Home Capital Group, which generally target riskier borrowers with lower credit scores, may find themselves scrambling for business now that mortgage clients have to qualify for loans at higher interest rates.
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