High house prices and the associated debt burden are a major vulnerability for Canada’s economy, the Bank of Canada said Thursday, warning buyers who bought during the pandemic that the impact of Even slightly higher mortgage rates could be dramatic.
In its review of the financial system, the central bank said that while the country’s financial system is strong and has withstood the pandemic well, the economy remains vulnerable due to high levels of debt linked to the real estate market each year. increasingly expensive in the country.
“While the average household is in better financial shape, more Canadians have stretched out to buy a home during the pandemic,” Bank of Canada Governor Tiff Macklem said Thursday. “And these homes are more exposed to higher interest rates and the possibility of house prices falling.”
The bank said the assessment of the risks associated with high levels of household debt has become more complex, but overall “the vulnerability has increased”.
About two-thirds of Canadians own homes, and about half own homeowners, while the rest have some form of mortgage-linked debt.
Rising lending rates slowed the housing market
Home prices rose by about 50 percent, on average, during the pandemic, as low rates allowed buyers to opt for larger loans while keeping current payments relatively affordable.
Much of these inflated house prices have been built on debt. Nearly one in five Canadian households is now considered “heavily indebted”, which means that their debt-to-income ratio is 350% or more, according to the bank.
Before the pandemic, only one in six was in debt. Just 20 years ago, in 1999, only one in 14 households had so much debt.
“These figures mean that each rate hike will inflict more pain on the economy than in the past,” said Desjardins economist Royce Mendes.
And these rate hikes have already begun. After cutting its benchmark interest rate at the start of the pandemic, in March 2022 the bank began raising its benchmark interest rate by 0.25% earlier this year in 1.5% current, and the impact on the housing market has been has been almost immediate, with a slowdown in sales volumes, along with average selling prices.
“Given the unsustainable strength of housing activity, housing moderation would be healthy,” Macklem said. “But high household debt and high house prices are vulnerabilities.”
As part of its analysis of how resilient the financial system is in the face of various shocks, the bank examined how the impact of higher rates and lower selling prices could be.
Mortgage costs could rise by 30%
As part of this, the bank analyzed the figures on what could happen to the mortgages of recent homeowners when their loans are renewed in five years.
The bank assumes that in 2025 and 2026, variable rate loans will cost 4.4% in five years, while fixed rate loans will be slightly higher than 4.5%.
Both scenarios are about two percentage points higher than what is on the market today.
In this scenario, the 1.4 million Canadians who got a mortgage in 2020 or 2021 would see their average monthly cost increase by $ 420, or 30 per cent after renewal.
The impact on fixed-rate borrowers would be slightly lower, as they would see their payments go from $ 1,260 on average to $ 1,560 a month, an increase of 24 percent.
But variable-rate borrowers are even more vulnerable, according to the bank’s thinking exercise, as their typical monthly payments go from $ 1,650 a month right now to $ 2,370 when they are renewed. This is an increase of 44 percent.
“If people in heavily indebted households lose their jobs, they would probably have to cut their spending drastically to continue servicing their mortgage,” Macklem said.
“This is not what we expect to happen … But it is a vulnerability to monitor closely and manage carefully,” Macklem said.
Other risks beyond housing
Vulnerability in the housing market was only one part of the Review of the financial system, which is the bank’s comprehensive assessment of the health of the economy and its ability to withstand various shocks.
Some of the other vulnerabilities mentioned include cyber threats due to the interconnected nature of the financial system and the fragile liquidity of fixed income markets.
The bank also warned about the growth of cryptocurrencies and their volatility.
“Like other speculative assets, cryptocurrencies are vulnerable to large, sudden price falls. And recently, some stable currencies have failed to live up to their promise of stability,” said Deputy Governor Carolyn Roger.
The bank also says Russia’s invasion of Ukraine has further complicated the transition to a low-carbon economy and assets exposed to the fossil fuel sector, such as those in pensions and savings. the retirement of many Canadians is in greater danger of being worthwhile. much less than expected.