Vulnerability to high household debt has worsened in Canada, and the rapid escalation of home prices in Vancouver and Toronto is a key factor, the Bank of Canada said today in its review of financial systems.
The Bank of Canada says that foreign demand in those two markets is one factor contributing to the soaring residential real estate prices that have driven up the level of household indebtedness in Canada. However, the bank says that foreign demand does not directly increase the risk of a price correction.
The bank says it is unlikely that recent price increases are sustainable: “The rapid pace of price increases seen over the past year also raises the possibility that prices may be supported by self-reinforcing expectations, making them more sensitive to an adverse shock to housing demand.”
The latest statistics released from the Real Estate Board of Greater Vancouver showed that prices continue to accelerate; Greater Vancouver prices are 30% higher than one year ago.
In Vancouver and Toronto, the availability of mortgage credit and ever-rising home prices are now “reinforcing each other” and the share of households with a large mortgage compared to their incomes has increased.
This could lead to “consequences” for mortgage lenders and insurers, but the central bank expects that rising incomes and the eventual increase of interest rates from historic lows will reduce this risk in the future.
The share of mortgages with high loan-to-income ratios has been rising, especially in Vancouver and Toronto.
“A higher LTI mortgage would typically result in households making larger payments relative to their income,” says the report. “However, a greater share of households with uninsured mortgages — 46% in 2015 compared with 42% in 2014 — are using an amortization period of more than 25 years.”
A longer amortization period reduces the monthly payments, but leads to higher indebtedness because it takes the homeowner longer to pay the mortgage off.
Debt vulnerability has also increased for regions hard-hit by the oil price shock, but for the rest of the country the risk hasn’t increase, with debt and income “growing moderately.”
Vancouver and Toronto are outliers in the Canadian housing market, and the rapid price growth seen in those cities goes beyond fundamentals like strong economic and population growth: people are paying big prices because they think property values will keep going up.
“The rapid pace of price increases seen over the past year raises the possibility that prices are also being supported by self-reinforcing price expectations,” says the report.
Vancouver and Toronto’s soaring home markets contrast sharply with those in Alberta and Newfoundland, which are struggling with job losses caused by the drop in oil prices.
The Bank of Canada says Canada’s major banks would be resilient to a “scenario that includes a large, persistent and widespread rise in unemployment, as well as a significant drop in oil and house prices” and that Canada Mortgage and Housing Corporation has “sufficient capital to handle an extreme but plausible house price correction.”
The federal government has promised to further study housing market unaffordability; Scotiabank and National Bank recently called on the government to gradually increase the minimum down payment on a home from 5% to 10%.
@jenstden
