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Expect some turbulence

We can’t say people weren’t warned.

Several years of low interest rates have some hoping it’s the norm. Report after report more recently say many households will be in trouble when they do ultimately rise again, but it’s hard to see whether the message is sinking in.

The latest red flag comes from Canada’s parliamentary budget officer, who said in a report Tuesday that many households will be vulnerable when rates rise. Many owners are overextended in what they owe, largely because they have benefited from rock bottom rates set after the economic downturn of 2008-09.

Hints are that those interest rates will slowly begin to rise soon – some analysts are predicting that will happen as early as this year. Households with no wriggle room in their budgets, still owing substantial amounts in mortgage and other consumer debt, will not be able to keep up with the demands of higher payments or accumulating interest.

The country's debt service ratio – the household debt payments relative to disposable income – has already climbed above the historical average seen between 1990 and 2017, said Mostafa Askari, the assistant parliamentary budget officer.

It’s only been a sputtering economy that’s kept rates down. As it strengthens, however, the Bank of Canada is hinting at an imminent hike – the benchmark rate of 0.5 per cent hasn’t seen an increase in seven years. But the PBO projects it will rise to three per cent by the middle of the next decade.

Banks seem willing to provide credit to borrowers without taking into account what a change in rates – or the borrower’s earning power – would mean.

It could be worse, however, we could be living in a country where rules are less stringent. In that regard, it’s worth remembering what led to the financial woes that began late last decade. Borrowers in the U.S. were overextended and the housing boom was a bubble ready to burst.

The resultant crash might have come as a surprise to the average person, but was fully anticipated by those in Canada’s finance industry. They knew it was just a matter of time until foundering lending institutions had to call in loans and the money just wasn’t there, leaving owners defaulting on mortgages. And surplus empty homes can only lead to plummeting prices.

No one expects such a stark result this time around, but it’s a lesson to remember. Canadian lending rules are more stringent than what truly was the wild west in the U.S. in the early 2000s.

But the more households experience serious trouble in coming years, the more we can expect housing and related industries to feel the effects.

Canadians are a little too overconfident when it comes to borrowing compared to a generation ago, when interest rates were much higher. They would do well to pay more attention to the whims of finance history.

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