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Small rate hike could hurt many households: DBRS

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BEST OF BNN: Most heavily indebted Canadians are keeping their heads above water for now, but an interest rate hike of just two percent could make home ownership unaffordable for many, according to a new study by a well-known Toronto ratings agency.

Cheap borrowing costs have helped push Canadian household debt to historic highs. Mortgage and consumer-related debt reached $1.6 trillion in 2011, according to the study by Dominion Bond Rating Service (DBRS).

What's more, Canadian households have debt equal to 153 percent of their income. This is lower than in the U.S., where debt to income is as high as 167 percent. Nevertheless, DBRS says some Canadians are highly exposed should conditions change.

"Canadian households are more highly leveraged than in the past, taking on more risk and more vulnerable to economic or event shocks than before," the study says.

"Compared with previous economic cycles when interest rates rose, the effect of any interest rate increases in the near to medium term will be more significant and presents a more elevated risk."

Not just an interest rate hike, but unexpected events, such as disability, divorce or dismissal, could also push some households to the limit, DBRS says.

Affordable housing should cost less than 30 percent of gross household income, according to the Canada Mortgage and Housing Corporation. These costs include mortgage payments, property taxes, condo fees and utilities.

If mortgage rates see a two-percent uptick, housing costs could balloon to as much as 43 percent of gross income for those with conventional mortgages; or rise up to 49 percent for those with insured mortgages, DBRS says.

The real estate market for most Canadian cities appears to be "moderately" overvalued, but balanced, the study says. But, the agency expects home prices to have "limited upside" and may be at risk for a correction in the near to medium term.

"Barring a nationwide economic downturn, the impact of an interest rate increase or any price correction on mortgage defaults should be localized, with more elevated risk in certain markets and segments," one of the study's authors, Kevin Chiang, senior vice president - Canadian Structured Finance, says.

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