High house prices and debt loads associated with them are a major vulnerability to 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 Financial System Review, the central bank said that while the country’s financial system is strong and weathered the pandemic well, the economy remains vulnerable because of elevated debt levels tied to the country’s increasingly expensive housing market.
“Even as the average household is in better financial shape, more Canadians have stretched to buy a house during the pandemic,” Bank of Canada Governor Tiff Macklem said Thursday. “And these households are more exposed to higher interest rates and the potential for housing prices to decline.”
The bank said that assessing risks related to high household debt levels has become more complex, but overall “the vulnerability has increased.”
Roughly two thirds of Canadians are home owners, and about half of them own their homes outright while the remaining have some sort of mortgage debt attached to it.
Raising lending rates slowed housing market
Home prices increased by about 50 per cent, on average, during the pandemic, as low rates allowed buyers to qualify for larger loans while still keeping the ongoing payments relatively affordable.
Much of those inflated house prices have been built on a foundation of debt. Almost one in five Canadian households are now considered “highly indebted,” which means their debt to income ratio is 350 per cent or more, the bank says.
Prior to the pandemic, only one in every six were that much in debt. Barely 20 years ago, in 1999, only one out of every 14 households had that much debt.
“Those numbers mean that each rate hike will inflict more pain on the economy than it would have in the past,” said Desjardins economist Royce Mendes.
And those rate hikes have already started. After slashing its benchmark interest rate at the outset of the pandemic, in March of 2022 the bank began to raise its benchmark lending rate from 0.25 per cent at the start of the year to 1.5 per cent today, and the impact on the housing market has been almost immediate, with sales volumes slowing, along with average selling prices.
“Given the unsustainable strength of housing activity, moderation in housing would be healthy,” Macklem said. “But high household debt and elevated 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 what the impact of higher rates and lower selling prices might look like.
Mortgage costs could go up 30%
As part of that, the bank crunched the numbers on what might happen to the mortgages of recent home owners when their loans come up for renewal in five years.
The bank makes the assumption that in 2025 and 2026, variable rate loans will cost 4.4 per cent in five years, while fixed rate loans will be slightly higher at 4.5 per cent.
Those rates represent about a two percentage point increase on where variable rates are today, and roughly equivalent to where rates already are right now on the fixed-rate side.
Under that scenario, the 1.4 million Canadians who got a mortgage in 2020 or 2021 would see their median monthly cost go up by $420, or 30 per cent upon renewal.
The impact on fixed-rate borrowers would be slightly less, as they’d see their payments go from $1,260 on average when they first got their loan, to $1,560 a month at renewal, for an increase of 24 per cent.
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