Despite the fact that I’m interested in the debate about whether we’re in a housing bubble and whether we’re headed for a housing crash that takes down our economy, I have no opinion myself. I care what happens, but I don’t know what will happen. Two of my favourite writers on this topic are Larry MacDonald, who likes to shoot down housing bear arguments, and Potato, who likes to shoot down MacDonald’s arguments. I won’t enter their debate except to make some observations about housing affordability metrics.
Housing bears tend to focus on debt-to-income ratios. They look at how many years of income your mortgage (and other debts) represent. Of course, you can’t spend all your income on debt repayment; there’s interest to pay, and you probably need to eat. So, the actual number of years needed to pay off a debt is much higher than the debt-to-income ratio.
If we focus on just the debt-to-income ratio, the situation in Canada seems dire. The average ratio in Canada keeps hitting new records. What is saving us is the current ultra-low interest rates.
This brings us to the other housing affordability metric: payment-to-income ratio. Because interest rates are so low, payments are low, and this metric doesn’t look so bad. In fact, we’re only slightly above the long-term average payment-to-income ratio. If we focus only on this metric, all seems right with the world.
So, which metric is right? In an interview with Preet Banerjee, Ben Rabidoux says that in most centers “we’re still above the long-term norm in terms of the percentage of income it takes to carry a mortgage and that’s with record low rates.” To those who say that we’re only marginally above long-term trends of affordability, Rabidoux says “I don’t see that as a good sign because we really don’t have a lot of downside in rates right now and so when they inevitably normalize that ratio or that reading is going to blow out quickly.”
Rabidoux is right that payment-to-income ratio doesn’t tell the whole story because interest rates are so low. If rates were to rise even modestly, this metric would rise very fast. On the other hand, debt-to-income doesn’t tell the whole story either because it ignores interest rates.
The truth is that the real picture is somewhere between these two metrics. If you read any argument that focuses on just one of these metrics without observing that today’s low interest rates make the metric somewhat misleading on its own, then you should be doubtful of the writer’s conclusions.