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PART TWO OF BNN'S WEEK LONG SPECIAL COVERAGE: RISKS AT HOME
Whenever home prices fall back to earth, Canada’s economy could lose a key pillar that’s helped drive consumer confidence.
It’s called the wealth effect. Soaring home prices make us feel rich and we spend more money on that new television or other goods and services that help propel the country’s economic growth.
And it’s that consumer spending, fuelled by the housing boom, that’s kept the economy moving since the Great Recession.
But when it comes to the wealth effect, if home prices simply level out it could evaporate - undercutting consumer spending in the process.
TD Economics says for every $1 increase in the value of your home you spend an extra 5 cents on consumer goods.
That’s considered an “indirect” impact, over and above direct impacts such as new home construction and activity related to existing home sales.
TD says those direct impacts account for nearly 20 percent of the economy. When you add in the wealth effect, housing is responsible for “as much as one-third” of activity in certain years, according to the bank's economics team.
But TD expects home prices to moderate – and could even drop as much as three percent over the next two-to-three years.
That could compound the financial strains that some Canadians are already feeling. Many consumers who scrimped-and-saved to just get into the housing market are living on the edge.
A recent survey from Manulife Bank found that nearly 40 percent of homeowners didn’t have enough money to pay all their bills in the past year.
“It’s a factor of people stretching to buy their houses and the amount of money they have to save just for the down payment,” Manulife Bank CEO Rick Lunny.
“There just isn’t a lot of money left over for events or circumstances they haven’t considered.”
The other wild card threatening to derail the housing-driven consumer boom is interest rates. Homeowners may be able to ride out a drop in home prices or a rise in interest rates; however, some observers worry they won’t be able to handle both.
The average debt load of $1.65 in debt for every dollar of income works out to more than $1.8 trillion in total consumer debt.
A growing part of that comes from homeowners borrowing against the equity of their homes. Canadians now owe more than $260-billion on their home lines of credit – up from just $35-billion in 2000.
A rise in interest rates will make it harder for Canadians to service those debts.
Would you cut back on spending if the value of your home dipped?— BusinessNewsNetwork (@BNN) December 1, 2015
But the day of reckoning isn’t imminent. BMO says interest rates are likely to stay low for the foreseeable future.
“People are worried about five-year fixed mortgage rates pushing back up to 5.5 percent... and cracking the housing market,” said Kavcic.
“I just don’t think that’s going to happen… I think normal is probably in the high-three percent, low-four percent range.”
And that would keep the wealth effect in effect for longer.