High house prices and related debts 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 a review of the financial system, the central bank said that while the country’s financial system is strong and resilient to the pandemic, the economy remains vulnerable due to rising debt levels linked to the country’s increasingly expensive housing market.
“Although the average household is in better financial shape, more Canadians have tried to buy a house during the pandemic,” Bank of Canada Governor Typh McLem said Thursday. “And these households are more exposed to higher interest rates and the potential for house prices to fall.
The bank said assessing the risks associated with high levels of household debt has become more complex, but overall “vulnerability has increased”.
Approximately two-thirds of Canadians own homes, and about half of them own their homes directly, while the rest have some form of mortgage debt.
Rising interest rates on loans have slowed the housing market
Housing prices rose by an average of about 50% during the pandemic, as low interest rates allowed buyers to qualify for larger loans while keeping current payments relatively affordable.
After lowering its base rate at the start of the pandemic, in March 2022 the bank began raising its base rate on loans from 0.25% at the beginning of the year to 1.5% today, and the impact on the housing market was almost immediate, with sales slowing along with average sales prices.
“Given the volatile strength of housing, moderation in housing would be healthy,” MacLeom said. “But high household debt and rising house prices are vulnerabilities.”
As part of its analysis of how resilient the financial system is against various shocks, the bank examined what the impact of higher interest rates and lower selling prices might look like.
As part of this, the bank is analyzing what could happen to mortgages of recent homeowners when their loans are renewed after five years.
The bank assumes that in 2025 and 2026 variable interest rate loans will cost 4.4% for five years, while fixed interest rate loans will be slightly higher – 4.5%. Both scenarios are about two percentage points higher than what is available on the market today.
Mortgage costs can increase by 30%
Under this scenario, 1.4 million Canadians who received a mortgage in 2020 or 2021 will see their average monthly spending increase by $ 420, or 30 percent on renewal.
The impact on fixed-rate borrowers will be slightly less, as they will see their payments increase from an average of $ 1260 to $ 1560 per month, an increase of 24%.
But variable-rate borrowers are even more vulnerable according to the bank’s exercise, as their typical monthly payments range from $ 1,650 a month now to $ 2,370 when they renew. This is an increase of 44 percent.
“If those in heavily indebted households lose their jobs, they will probably have to cut costs sharply to continue servicing their mortgages,” McLem said.
“This is not what we expect to happen… But it is a vulnerability that needs to be closely monitored and managed carefully,” MacLeam said.
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