Maintaining low interest rates too long could spell trouble ahead: RBC economist

The household debt-to-income ratio in Canada surpassed that of the U.S. in 2011, according to the report, now at 147%, compared to 120% just a decade earlier. But while the U.S. ratio has declined since 2007, Canada’s has been rising.

“The very source of Canada’s relative success during the worst of the credit crunch – a banking sector that kept on lending and households that kept on buying – could yet spell its undoing if newly enlarged household debt loads prove too onerous to bear,” said Eric Lascelles of RBC Global Asset Management.

He said it’s a misconception that the Bank of Canada shouldn’t raise interest rates because of the negative affect it will have on mortgage holders.

“The longer the bank delays, the more marginal borrowers will enter the market and be walloped when rates rise, and the further home prices will go above their equilibrium levels, only to tumble later,” he said.

More and more Canadians are choosing home ownership -- a trend that was partially caused by a rise in average household income, said Lascelles.

But while Canadian households have debts valued at 1.5 times their annual disposable income, they also have assets valued at 7.5 times their annual disposable income. Net wealth continues to grow, said the report, but there’s still a third of the population in Canada with debt as high as three to five times their annual income.

Lascelles also examined the housing markets of various cities in Canada. While Vancouver has historically been pricier than other Canadian cities, there is reason for special concern this time around. “There remains a significant and growing affordability gap in the city, and it should be viewed as the canary in the coal mine for the rest. Whatever happens to the country, Vancouver should lead the way.”

Toronto, Calgary and Edmonton are more reasonably priced, but a rise in interest rates could change that very quickly.

“Home prices are perhaps a touch too high today, but will be substantially too high once interest rates rise,” said Lascelles.

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