There are more than 700,000 Canadians who might be watching the next Bank of Canada decision very closely, because even a modest interest rate increase could push them over the financial edge.
A new study out Tuesday from credit agency TransUnion shows that of the 26 million credit-active Canadians in the country, 718,000 can’t absorb a 25-basis point increase or they won’t have enough cash flow to cover their debts. Raise rates one percentage point, something not likely to happen overnight, and 971,000 Canadians end up in a cash crunch.
The next interest rate announcement is not due until mid-October but the consensus among economists is there will not be a rate hike until the third quarter of 2017. That may be part of the problem, since consumers have come to expect rates will never go up and are now borrowing based on a prime lending rate of 2.7 per cent.
“I would say for five or six years interest rates have been so low, a lot of these consumers look okay because of the low rate environment. This is one of the things we are looking at,” said Jason Wang, director of research and industry analysis with Chicago-based TransUnion. “If everything changes and interest rates are higher, and they have to pay more on a monthly basis back to lenders, they may not be able to handle (an increase).”
The report looked at so-called super prime customers — the people with the best credit and scores in the 830-900 range — who make up the largest segment of the credit-holding population unable to absorb a small increase. Of super prime customers, TransUnion says a 25 basis point increase to interest rates would cause cash-flow trouble for 239,000. Only 101,000 Canadians borrowing with sub-prime ratings, in the range of 300-599, would face the same cash crunch under those circumstances.
Wang said the super-prime customers are far more leveraged and therefore more vulnerable to an interest rate increase. If rates rose one percentage point, 298,000 super-prime customers would face cash flow problems.
On average, credit-active Canadians carried 3.7 credit products, TransUnion said. The study focused on two major types of debt that carry variable rates, including lines of credit and variable-rate mortgages.
The message to consumers is to pay down debt before interest rates start to rise, while issuers need to look at their books.
“Take a look at their prime- and super-prime customers to see if they have a problem, because these are the people who will be surprised,” Wang said. “We don’t want creditors to be surprised.”
Laurie Campbell, executive director of Credit Canada, said high quality customers have been building up debt because they’re attracted to low rates that never seem to rise.
“There is an assumption that those with better income and good (credit ratings) are in good financial shape,” Campbell said. “It’s not the case at all. We see people in our offices all the time that should be managing well that are not due to a number of factors. One is over extension, they’re biting off more than they can chew.”
Source: Financial Post Gary Marr | September 13, 2016 | Last Updated: Sep 13 8:43 PM ET