As Rate Increases Canadians in Debt Face Some Dangers ‘Beyond Historical Experience’: PBO

Canadians will have to allocate an unprecedented percentage of their salary to arrears repayment if interest rates return to a normal level according to a new report.

According to those predictions, if the bank of Canada were to increase the key interest rate from the 0.5% to 3%, the average Canadian family will have to use 16.3% of its disposable salary to pay arrears by the end of 2021.

“The financial vulnerability of the average household would rise to levels beyond historical experience,” the Parliamentary Budget Officer (PBO) warned today, based on projections about interest rates, household debt and debt servicing costs.

Canadians now require 14.2% of their after tax to keep up with principal and dividend payments and have never used more than 14.9 % of their income to settle debts, the PBO noted. Below is how much interest will increase by the end of the year:

#Mortgages;

The interest rate on mortgage debt could climb from 2.9 percent to 4.8 per cent by the end of 2021, according to the PBO. This will affect home-buyers. However, the vast majority of Canadians, who have fixed-rate mortgages, won’t feel the impact of higher rates until their loan is up for renewal. And at 4.8 percent, the interest on mortgage debt would still be below Canada’s long-term average of 5.4 percent, the PBO noted.

#Non mortgage debt;

Interest rates on arrears other than mortgages — such as unsecured lines of credit and credit cards — will likely go from 5.4 percent to 7.6 percent by the end of 2021. That would abandon rates at a level just shy of the historical average of 7.7 percent, the PBO reported.

#The BoC’s key interest rate;

This is the interest rate that influences most other interest rates throughout the economy. When the BoC increases it, the cost of borrowing increases for most Canadians. The bank uses this level of interest rates to keep inflation in check and promote economic stability and employment. As the Canadian economy heats up, the BoC has said it is thinking about finally lifting rates from the historic low levels where they’ve been for years. The first hike could happen as soon as July, according to Bank of Montreal. The PBO projected the key interest rate to rise from 0.5 per cent today to 3 per cent by mid-2020.

For some time at least. Canadians will continue borrowing even if the debt becomes more expensive, says the PBO. As a result by the end of the forthcoming year, Canadians will likely owe $1.80 for every dollar of disposable income, up from the ongoing $1.74. The PBO expects household rent to be stable from 2018.

Canadians have kept their borrowing in check over the past couple of years, but didn’t quite halt piling on arrears, the report suggests. As a result, household arrears as a percentage of disposable income continued to grow, even if interest rates kept reducing.

Now that rates are set to increase, Canadian households are on path to become more financially stretched than they’ve ever been before.