Nearly 1M Canadians may struggle when interest rates rise
A new study by TransUnion found that the large majority of Canadians would not be materially impacted in the near term by an interest rate increase.
However, more than 700,000 consumers could struggle with their finances — which might include staying current on their vehicle installment contract — even with a quarter-point hike, and up to 1 million borrowers may not be able to absorb the increase in their monthly payments if interest rates rise by 1 percent.
“Despite rising debt loads for Canadians, our study found that the far majority of consumers will be able to manage an interest rate hike of up to 1 percent,” said Wang.
“Our assessment, though, identified a subset of the population of nearly 1 million borrowers who may face financial challenges when rates rise.”
Interest rates in Canada have remained low for several years, and the Bank of Canada Target Overnight Interest Rate stands at 0.5 percent. This is the benchmark interest rate set by the Bank of Canada at which major financial institutions lend overnight funds among themselves; changes in this target rate influence other interest rates, including the Prime business rate, currently standing at 2.7 percent.
Most finance companies price loans based on the Prime rate plus some margin.
TransUnion recounted that the Target Overnight Interest Rate peaked near the end of 2007 at 4.5 percent. Since then, it declined to a low of 0.25 percent (where it remained for much of 2009) and now stands just above that level at 0.5 percent. It is expected that this and other interest rates will rise in the future, though the timing and magnitude of any rate increases remain uncertain.
TransUnion’s study determined that there are more than 26 million credit-active Canadian consumers, and on average, they carry 3.7 credit products each. The study focused on two major types of debt that carry variable interest rates that typically adjust when benchmark interest rates change: lines of credit and variable-rate mortgages.
Approximately 7 million Canadian consumers carry at least one of these two variable interest rate debt types. These loan types are most impacted by interest rate changes and can create a payment shock —the increase in borrowers’ monthly payment obligations that they cannot control.
Rate hike will impact several hundred thousand consumers
While the far majority of Canadians will not be negatively impacted in the near term by an interest rate increase, TransUnion emphasized there is a material subset of the population that may find it difficult to absorb an increase.
The study found that a ¼-point interest rate increase may seriously impact 15 percent of the population that currently has a variable-rate mortgage, a line of credit, or both. These consumers would see a $50 or more increase in their monthly payments. A ½-point interest hike and a 1-point increase would cause 30 percent and 40 percent, respectively, of the above-mentioned population to have a monthly payment shock of $50 or more.
“The size of the monthly payment shock is only one side of the equation,” said Wang. “For some, a $50 increase in their obligations may simply be managed by forsaking a couple of restaurant dinners and eating at home, while for some others, this may mean they would not be able to fill their gas tanks to get to work.
“So we need the other side of the equation: comparing the payment shock with consumers’ available cash flow,” he continued.
Trended credit data now available on TransUnion’s CreditVision consumer credit report can provide an accurate assessment of consumers’ available cash flow and capacity to absorb increased payment amounts based on historical payment amounts.
These insights revealed that, with a ¼-point interest rate increase, 718,000 consumers might not be able to absorb the ensuing payment shock. An additional 253,000 consumers might not be able to absorb the shock if the rate were to rise by a full percentage point.
Among these at-risk consumers, more than 650,000 currently have credit scores that put them into prime or better risk segments — segments that are generally considered to be low risk.
“This is especially compelling news for lenders, as hundreds of thousands of borrowers traditionally believed to be low-risk consumers may suddenly become risky,” Wang said. “While lenders expect subprime consumers to be risky, this sudden change in prime or better segments may come as an unpleasant surprise.
“Based on this study, we recommend lenders evaluate their own portfolios in a similar manner to determine who might be vulnerable to a payment shock among their customers, and work with those customers to ensure their accounts remain in good standing,” he continued.
“This is a key point of the study — to understand and measure the size and magnitude of the potential impact — so that both consumers and lenders can be better prepared,” Wang went on to say.