Bank of Canada warns of risks from household debt and housing market

The Bank of Canada issued a warning Thursday about the country’s over-heating housing market, saying that households are piling on too much debt that could come back to bite them and the economy post-pandemic.

In its latest financial system review, the Bank of Canada said many households have taken on large mortgages compared with their income, limiting their flexibility to deal with an unforeseen financial shock like the loss of a job.

Total household debt has increased by 4% since the start of the pandemic, picking up sharply since the middle of last year as the housing market started to heat up. The percentage of costly loans, defined by the bank as those more than 4.5-times a household’s income, have also risen above the peaks seen five years ago when policy-makers tightened mortgage rules.

The Bank of Canada’s report said the current housing boom may help the economy rebound in the short-term, but could lead to a future bust if households have to cut spending because of another downturn.

And by biting off more than they can chew with a new mortgage, governor Tiff Macklem warned it may make those households more vulnerable to rising interest rates when it comes time to renew their loans, adding it was up to Canadians and lenders to be prudent.

“The current rapid increases we’ve seen in prices – don’t expect that those will continue indefinitely,” Macklem told a news conference.

“Don’t expect that you can pull equity out and refinance your mortgage in the future on the basis that prices are going to continue to go up like we’ve seen.”

House prices were up 23% nationally relative to a year earlier, the bank said in its report. The Canadian Real Estate Association said this week that the average price of a home sold in Canada in April was just under $696,000.

The bank said the surge in prices is more widespread in cities than five years ago, when things were largely concentrated in and around Toronto and Vancouver. In the bank’s view, the Greater Toronto Area, Hamilton and Montreal are overheated and Ottawa is on the precipice of joining them.

With house prices rising, and supply of available homes lagging demand, some homeowners may be tempted to buy now out of concern that they won’t be able to afford something in the future.

The bank’s report said that the activity in the housing market and troubling figures on mortgages is reminiscent of 2016 just before stress tests were brought in on mortgage applications to make sure buyers could handle payments if interest rates rose.

Later Thursday, a federal bank regulator made official its plan to tighten its stress test. The Office of the Superintendent of Financial Institutions (OSFI) said that effective June 1, the qualifying rate on uninsured mortgages would be set at either two percentage points above the contract rate, or 5.25%, whichever is greater.

“We want to make sure that households when they are taking out a mortgage now, they fully understand, and the lenders fully understand, and everybody is assured that Canadians can afford that mortgage when interest rates do eventually go up,” Macklem said earlier in the day about the OSFI test.

Raising the bank’s trend-setting policy rate isn’t simple, Macklem said, noting that there are swaths of the economy that still need central bank support and a labour market that needs to create some 700,000 jobs to get the employment rate to where it needs to be.

That’s why the Trudeau Liberals have been pressed to tighten the rules for insured mortgages.

The federal budget last month proposed a one per cent foreign-buyers tax on vacant property. The central bank said the measure “would likely reduce speculative demand in the housing market.”

On Wednesday, Finance Minister Chrystia Freeland met with a panel of private sector economists. A readout from the meeting provided by Freeland’s office noted that she asked about the housing market and affordability issues.

The central bank’s latest review of the risks to the financial system also highlighted concerns about a too-soon withdrawal of government aid for businesses. Companies are concerned about their future viability when government support ends because much remains uncertain about what post-pandemic life and economic activity will look like, the central bank said.

For banks and insurance companies, the Bank of Canada said cybersecurity remains one of their top concerns.