Mortgage rate increases spell pain for borrowers, but not the economy

Mortgage borrowers in Canada should expect soon see more of their income going toward debt servicing, Big Six bank warns

Mortgage rate increases spell pain for borrowers, but not the economy

The country's most heavily indebted consumers are feeling the pressure of rising mortgage rates, but it won’t be the same for the overall economy, according to one of Canada’s big banks.

A recent note from National Bank Financial cautions that mortgage holders will eventually use a greater portion of their income to pay off debt. On a nationwide scale, though, the percentage of income that mortgage borrowers will use to pay down debt isn't very high.

As explained in Better Dwelling, most Canadians are homeowners who do not have mortgages. Because of that, rising rates and household debt aren't anticipated to be enough to start a recession on their own.

While households in Canada with significant levels of debt will likely be able to weather the storm of increased mortgage rates, it will cost them far more. According to National Bank, borrowers who borrowed at 4.5 times their gross annual income could face a hike in their payments of between $187 and $281 per month.

That would translate to a 2.6% to 6.0% hit to their net disposable income. While borrowers have been stress-tested to ensure they could absorb that impact, it will still represent a diversion from their normal consumption.

The lion’s share of Canada's high levels of debt is held by households with higher incomes. Because of that, the bank estimates that rising mortgage rates will only lead to a 0.65 percent loss in disposable income at the national level during the following three years.

“The amount is significant but manageable in that it alone will not suffice to pull the economy into a recession,” wrote Matthieu Arseneau, NBF’s deputy chief economist. 

Despite Canada's staggering mortgage debt, the vast majority of households have none. Only 35% of families, according to NBF estimates, have mortgages and will be affected by rising rates. That’s the lesser evil compared to inflation, which will weigh heavily on all households if left unchecked.

Although debt servicing results in a sizable loss of income, the bank highlighted that it is insufficient to bring about a recession on its own.

However, increased rates by themselves won't cause a recession to occur. It may become a bigger problem if it’s accompanied by the negative wealth effect, which is when a decline in asset values causes consumers to cut back on their spending. That means recession is still a very real threat, the bank says, as housing and stock prices may correct.

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