Borrowing Costs on the Rise for Canadians

It looks like Canadians may be in for a rough ride when it comes to household debt. According to TD Economics, the debt service ratio (the amount of disposable income that goes towards paying off debt) is set to hit a record high by the second half of next year. This is due in part to the Bank of Canada's recent interest rate hikes, which have brought the rate from 0.25% at the beginning of 2021 to 4.25% in December. TD expects one more hike that will bring the policy rate to 4.5% by the first quarter of 2023.

While these interest rate increases have been happening all year, the impact on household budgets has been delayed because mortgages and loan payments are renewed at current market rates. However, new borrowers are already feeling the effects of these higher rates, with variable-rate mortgages climbing along with the Bank's increases and fixed-rate mortgages rising by more than 200 basis points.

During the pandemic, the household debt service ratio for Canadians declined to 13.3% of disposable income from a peak of 15% in late 2019. However, this ratio is expected to rise again as loans renew at higher rates or Canadians take on more debt at current market rates. The effective interest rate, which is calculated by dividing total interest payments by total debt, has already risen from 3.4% in the first quarter to 4.2% in the third quarter and is predicted to continue rising to over 6% in the first quarter of 2024.

Fixed-rate mortgage borrowers, who make up about 18% of the market, will also be facing the highest interest rates in 20 years when their mortgages come up for renewal next year. And even with a predicted decrease in household borrowing over the next year, debt service costs are still expected to rise. TD estimates that the debt service ratio, which has already risen from 13.3% at the beginning of the year to 14% in the third quarter, will likely increase by another two percentage points to reach 16% by the second half of next year, surpassing the pre-pandemic peak of 15%.

While Canadians may have accumulated personal savings during the pandemic, these savings may be needed to cover the rising debt costs as interest rates are expected to remain at high levels throughout 2023. It's important for households to be aware of the potential impact on their budgets and to make a plan for paying off debt and managing their finances in the face of these rising costs.