Bubble seeks air

This makes me nervous:

Mortgages getting risky: CIBC

HEATHER SCOFFIELD

Globe and Mail Update

TORONTO — Household credit is stable, but that statement masks the growing popularity of untraditional and risky mortgages, a new study by CIBC World Markets says.

Household credit is growing steadily at an 11-per-cent annual pace, pushed by a 10.9-per-cent rise in residential mortgages for year ending in April 2006, according to the report.

Growing by 11% per year is not exactly stable. The catch is that household incomes are not rising by 11% per year. According to Statscan’s Incomes in Canada, median total income for Canadian families was $63,100 in 2004 (last data year), or about $800 higher than in 2001, after adjusting for inflation which has been in the 2-3% range over most of this period. 2005 and 2006 may have been good years but I doubt that incomes have gone up 20% in nominal terms. This means debt loads are getting heavier as people buy into the real estate boom.

It says non-bank mortgage providers took a bigger share of that growing market. Banks account for about 75 per cent of the mortgage market, but they only saw their mortgages outstanding grow by 4.3 per cent in the past six months. Non-traditional lenders, on the other hand, saw a 9.1 per cent gain in their mortgages outstanding.

This is a sign of a “maturing and more dynamic mortgage market,” the report says, as non-traditional lenders compete with banks by offering American-style sub-prime loans, increased amortization periods or interest-rate-only mortgages.

The power of low interest rates is to make you able to carry a larger mortgage for the same level of income. But interest rates are now back up: the bank rate was 4.5% in May, the same rate as in July 2001, or just before 9/11 led to a huge drop in short-term rates. Mind you, the rate was 6% as of December 2000, and post 9/11 hit a low of 2.25% by early 2002.

Nonetheless, the central bank has effectively taken away the punch bowl, as they say. How painful will the hangover be?

Long-term rates never fell that much, either, as most of the action was in short-term rates. Five-year rates fell by about one percentage point from the first half of 2001 to the first half of 2002.

Alas, the meme of “low interest rates” is still out there and this psychology is still affecting the real estate market.

The advent of American-style loans will keep the party going but the danger for buyers right now is getting locked into large mortgages that will deplete their purchasing power elsewhere in their household budget. And if unemployment goes back up to the 8-10% range, look out for some people to just walk away from their mortgages.