We have long seen those speculations on the house prices and mortgage interest rates. There is reasonable basis to believe that the house prices are – to some extent – being skewed by the low interest rates. The question was always – how exactly they are related?
The major difference between a consumer loan like credit line or credit card and mortgage is that a mortgage amortizes over a very long period of time. The issue with the short term (supposedly) consumer loan is that it tend to last for ever.
In old days, the fear of future interest rate hike always scared consumers to pay off those loans quickly. Now, the excuse of weak global economy kept the printing machine on overtime – for more than a year – consumers are getting used to with it.
Whatever the case is, we never like to pay too much interest. So, we started to consolidate our debts – meaning, we paid off credit cards loans by borrowing from low interest credit lines.
Noticing that, some people thought why not use that credit line for something else? Therefore consumers started to borrow from credit line – often backed by the home – and started using that money to buy another investment home or a vacation or RRSP and for many other purposes.
Finally the government said enough is enough, as they did not want this popular public habit to add risk to public pocket, thus they stopped insuring those HELOCS.
Borrowers and lenders, both, proved to be very creative. Once the existing mortgage is up for renewal people started to refinance their homes and flow of money never stopped.
As we said earlier – when you borrow money – money is born – and when you pay off the loan – money is destroyed. Technically there should be nothing called “Dead Money” – as once phrased by Mark Carney. When loans are paid off – reserve ratios of the lenders go up. Since lenders are under constant pressure to boost their quarterly dividends – they thought of un-secured credit lines as one of the many ways to send that money back into the market. OSFI intervened and tried to control this type of lending too.
The household lending in Canada is larger than business lending (RBC). Residential mortgage is two third of total household debt and the remaining third is credit cards and credit lines. A big pie indeed. But people already have debt, how would they put the down payment to buy that home? Well, you still can make a down-payment by borrowing the amount (McLister)
The circle of borrowing money to borrow more is healthy till the interest rates start to go up. This far BoC only managed to keep the rate same for couple of years, forget about raising it. We all now are comfortable with the idea of happy borrowing and if someone talks about raising rate – who know how public will react in the polling booths.
So, if you are desperate to purchase a home then your affordability depends on the amount of down payment you can make. More credit line will give more down payments – right? Finally our non-mortgage loan drives the amount of our mortgage. In reality the amount of down-payment becomes the main question not the house price.
The BoC working paper was about the relationship between house value and non-mortgage debt. The main conclusion of the paper was that the house prices are positively connected with the non-mortgage debts. Meaning, that you borrow more against your home on a HELOC and you get to borrow more if your house value is higher.
The only issue here is that the data and survey data are old – from 2007. In this six years many things have changed except people.