Auto Loan Delinquencies & Residential Mortgage Rates

As part of my business, I’ve connected with a lot of people over the past 38 years. These are a mix of clients, connections, and relationships built through many businesses and industries. What’s fascinating is to see how each of these people and their businesses interpret economic data and utilize it to make informed decisions. Of course, my focus is on the real estate market, particularly in Guelph, and I’m always keen to better understand what drives our local market.

I had an interesting discussion with a client in the finance and wealth industry about the rising trend in auto loan delinquencies. We were talking about how different industries can gauge how the economy is performing locally. We use mortgage default rates to gauge a slowing real estate market, but they argued that auto loan defaults were a more sensitive indicator of a weakening economy.

Well - I had to dig a little deeper on the topic! Auto loan delinquency rates do have broader implications, especially on residential mortgage rates and mortgage underwriting practices, which could potentially influence the stability of the housing market in this region. While this might appear to be one of those, obviously, moments it also might help explain why lenders haven’t been so quick to pass along the interest rate adjustments from the Bank of Canada.

The Rise in Auto Loan Delinquencies

In recent months, Canadian households have seen an uptick in auto loan delinquencies. The combination of high inflation, higher car loan interest rates, and a slowdown in wage growth has strained household budgets, making it challenging for many to meet their debt obligations. According to Equifax Canada, the auto loan delinquency rate has been steadily climbing, with an increase of 8.5% year-over-year in 2023. This rise is particularly pronounced in regions like southwestern Ontario, where economic pressures have been more acute due to the higher cost of living and an economy heavily reliant on manufacturing and services sectors.

Impact on Residential Mortgage Rates

The link between auto loan delinquencies and residential mortgage rates may not be immediately obvious, but it is significant. Higher delinquency rates in consumer debt, including auto loans, signal increased financial stress among borrowers. Lenders, in response to this rising risk, may adjust their overall lending strategies, including the rates they offer on residential mortgages.

In an environment where consumer credit risk is perceived to be higher, lenders might increase mortgage rates to offset potential losses from other areas of their loan portfolios. This could be particularly impactful in southwestern Ontario, where housing affordability is already a critical issue. Increased mortgage rates would further exacerbate the affordability challenge, potentially cooling the housing market as prospective buyers find it more difficult to qualify for loans or afford higher monthly payments.

Impact on Mortgage Underwriting

The rise in auto loan delinquencies also has a direct impact on mortgage underwriting practices. Underwriting is the process by which lenders assess the risk of lending to a borrower, and an important component of this assessment is the borrower’s overall debt load and credit history.With higher delinquency rates in other areas of consumer credit, such as auto loans, lenders are likely to tighten their underwriting criteria for residential mortgages. This could manifest in several ways:

1. Stricter Credit Requirements: Lenders may require higher credit scores or impose more stringent credit checks to ensure that borrowers are less likely to default on their mortgage payments.

2. Lower Debt-to-Income Ratios: Given the increased risk, lenders may reduce the acceptable debt-to-income (DTI) ratio for mortgage applicants, making it more difficult for individuals with significant auto loan or other consumer debt to qualify for a mortgage.

3. Higher Down Payment Requirements: Lenders might also demand larger down payments to mitigate the risk of default, which could further limit access to homeownership, particularly for first-time buyers in southwestern Ontario.

Implications for the Southwestern Ontario Housing Market

Southwestern Ontario, with cities like Guelph, Kitchener-Waterloo, and London, has been experiencing a robust real estate market driven by population growth and strong demand. However, the potential tightening of mortgage underwriting standards and the increase in mortgage rates could lead to a slowdown in the market.

First-time homebuyers, who are particularly sensitive to changes in mortgage lending criteria, may find it increasingly difficult to enter the market. This could lead to reduced demand for entry-level homes, potentially resulting in a softening of prices in that segment. Moreover, current homeowners who are looking to refinance may also face challenges, further dampening overall market activity.

The rise in auto loan delinquencies in Canada, particularly in southwestern Ontario, poses a significant risk to the broader financial system. As lenders adjust mortgage rates and underwriting practices to mitigate these risks, the impact on the housing market could be profound. For prospective buyers and current homeowners, staying informed about these trends is crucial, as they navigate a changing landscape in mortgage financing.

For personalized advice or more insights into how these trends may affect your real estate decisions, feel free to reach out. Staying proactive in understanding these dynamics can help ensure better financial decisions in a potentially volatile market.

Thanks for reading & enjoy the weekend!

Paul

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