Why debt is still a four-letter word for housing markets

One usually expects an increase in job losses to impact housing markets by triggering a decline in sales and mortgage debt. The COVID-19-induced job losses are different. Despite the increase in job losses, sales and mortgage debt have also increased in many cities across Canada.

Canada Mortgage and Housing Corp. (CMHC) in a report released in October warned about elevated household debt levels and the implications for the housing markets. The report said that heavily indebted households, the weakest link in the housing chain, might be forced to sell their homes if faced with a “prolonged negative shock” (jargon for long-lasting job losses).

The report also explained how COVID-19 had impacted the economic well-being of borrowers, lenders, homeowners and renters. For instance, if the negative economic impacts of the pandemic were to last beyond the period covered by stimulus-driven relief, loan forbearance and mortgage deferrals, households might be forced to reduce their financial obligations by selling their homes or drawing on their home equity.

The CMHC report compared household debt levels before COVID-19 (fourth quarter of 2019) and during (second quarter of 2020). It further distinguished between non-mortgage and mortgage debt, an increasingly relevant distinction because mortgage deferrals and loan forbearance may have allowed households to transfer spending from servicing debt to the consumption of consumer goods.

CMHC found that non-mortgage debt has declined since the end of 2019 across all major urban areas. The primary driver was the drop in outstanding credit card debt. CMHC believes that a decrease in spending during the pandemic is the reason for the decline.

Spending on restaurants and entertainment plummeted in mid-March, but it simultaneously increased elsewhere as households hoarded consumer goods such as toilet paper and paper towels. The decline in outstanding credit card debt could also have been driven by households having cash on hand to pay their credit card bills as they availed themselves of mortgage deferrals or relied on moratoriums on rental evictions.

But though outstanding credit card debt declined, the report mentioned a 4.4 per cent increase in home equity line of credit debt between the fourth quarter of 2019 and the second quarter of 2020.

Mortgage debt, on the other hand, increased in most cities, but declines were more pronounced in provinces already struggling with economic growth even before the onset of the pandemic. Thus, Calgary, Edmonton, Regina, Saskatoon and Winnipeg reported the largest declines in mortgage debt.

The total outstanding debt increased in only four urban regions: Abbotsford-Mission, B.C., Hamilton, Toronto and Vancouver. Abbotsford and Hamilton lie within the commuter shed of Vancouver and Toronto, respectively, where housing prices rapidly increased before the pandemic. This suggests that the increase in total outstanding debt was concentrated in and around the Toronto and Vancouver areas.

The CMHC report also noted that changes in mortgage debt levels are not explained by the decline in employment. The three cities reporting the highest increase in mortgage debt levels also reported higher-than-average declines in employment growth. This led CMHC to conclude that

“changes in employment were not a clear factor in the changes in mortgage debt since the onset of the COVID-19 pandemic.”

The disconnect between employment growth and mortgage debt levels suggests that job losses have increasingly spared homeowners, and likely disproportionately impacted renter households. The record year-over-year increase in sales during summer and fall in large urban centres suggests that employment uncertainty has not dampened housing aspirations of current and future homeowners.

Similar trends have been observed in the United States as well. TheFederal Reserve Bank of New York reported a “sharp decline in credit card balances” and an increase in mortgage debt in the second quarter of 2020. Unlike Canada, the U.S. experienced a decline in home equity lines of credit.

The record-low mortgage interest rates fuelled mortgage origination in the U.S., and the increase in mortgage origination was driven by credit-worthy borrowers. The report noted that the median credit score for newly originated mortgages in the second quarter was 784, the highest since 2000.

The second-quarter economic data is indicative of the bimodal economic realities in a pandemic-stricken global economy. In Canada and the U.S., mortgage debt has increased even with mounting job losses, suggesting that some sectors of the economy have suffered less under the pandemic than the rest.

TheOctober Labour Force Survey in Canada reported an increase of 84,000 jobs, which is welcome news, but it obscures the drastic increase in long-term unemployment. Of those who were unemployed in October, one in four has been unemployed for 27 weeks or more.

Housing sales have been resilient in the face of the economic downturn. They cannot, however, be immune to it. A continued increase in long-term unemployment is likely to take a bite out of the growing mortgage pie in the future.

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