Home-equity lines of credit and loans have surged in Canada, rising at almost twice the pace of mortgages over the past decade to account now for 12 per cent of overall household debt.
"Since these secured loans are offered at a lower interest rate than unsecured loans, consumers have used part of the funds to pay down other debts," Bank of Canada deputy governor Agathe Côté said today.
"Microdata suggest that roughly one-third of the loans are used to that effect, while about 20 per cent are used to invest in financial assets. The remaining half is spent on current consumption and renovating or purchasing another property."
These lower rates, coupled with rising house prices, have helped pump up credit levels, Ms. Côté said as the central bank again sounded alarm bells over high consumer debt levels.
"The main channel through which increases in house prices can raise household spending is called the financial-accelerator effect," she said in a speech in Kingston, Ont.
"When the value of a house rises, the owner can borrow against the increased equity through a home equity line of credit, a home equity loan or by simply increasing the size of the mortgage (an option for homeowners when they renew their mortgage, provided they have sufficient equity). The funds can be used to finance home renovations, a second house, or other goods and services.
"Such expenditures can accelerate the increase in house prices, reinforcing the growth in collateral values and access to additional borrowing, thus leading to a rise in household spending."
Household spending was key to Canada's recovery, but household finances have become "increasingly stretched."
Debt now stands at a record 148 per cent of disposable income, she said, while gains in house prices won't likely contribute to household wealth as they have recently.
"This, combined with the fact that the level of household debt has reached a record high, leads us to expect that the growth of household expenditures will slow to a pace closer to that of income," she said.
Ms. Côté noted the risks to the outlook for spending, and how that could ripple through the economy.
A sudden weakening in the housing industry could have "sizable spillover effects" through the economy, in areas such as spending, given such high debt levels.
"While residential investment declined in the second half of 2010, it still remains near historically high levels," she added. "The Bank expects some further weakening into 2011, reflecting subdued income growth and declining affordability, but not a major correction."
