Typical mortgage payment could be 30% higher in 5 years, Bank of Canada warns

High home prices and the associated debt burden are a major vulnerability for the Canadian economy, the Bank of Canada said Thursday, warning buyers who bought during the pandemic that the impact of mortgage rates even slightly higher could be dramatic.

In its review of the financial system, the central bank said that while the country’s financial system is sound and has weathered the pandemic well, the economy remains vulnerable due to high debt levels linked to the growing real estate market. expensive in the country.

“Even though the average household is in better financial health, more Canadians have been scrambling to buy a home 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 lower house prices.”

The bank said assessing the risks of high levels of household debt has become more complex, but overall “vulnerability has increased”.

About two-thirds of Canadians are homeowners, and about half of them own their homes, while the rest have some kind of mortgage debt attached to them.

Rising lending rates have slowed the housing market

Home prices have risen about 50%, on average, during the pandemic as low rates allowed buyers to qualify for larger loans while keeping ongoing payments relatively affordable.

Much of these inflated house prices have been built on a debt base. Nearly one in five Canadian households are now considered “highly indebted,” meaning their debt-to-equity ratio is 350% or higher, according to the bank.

Before the pandemic, only one in six people had this much debt. Barely 20 years ago, in 1999, only one in 14 households had this much debt.

“These numbers mean that each rate hike will inflict more harm on the economy than it would have done in the past,” said Royce Mendes, economist at Desjardins.

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Central bank governor Tiff Macklem said the economy needs higher interest rates to bring inflation down, despite the potential pain higher rates could bring to the housing market.

And those rate hikes have already started. After cutting its benchmark interest rate at the start of the pandemic in March 2022, the bank began raising its key rate from 0.25% at the start of the year to 1.5% today, and the impact on the housing market was almost immediate, with a slowdown in sales volumes, as well as average sales prices.

“Given the unsustainable strength of real estate activity, moderation in housing would be healthy,” Macklem said. “But high household debt and high house prices are vulnerabilities.”

As part of its analysis of the resilience of the financial system in the face of various shocks, the bank considered what the impact of a rise in rates and a fall in selling prices could look like.

Mortgage costs could rise by 30%

As part of this, the bank calculated what might happen to new homeowners’ mortgages when their loans come up for renewal in five years.

The bank assumes that in 2025 and 2026, variable rate loans will cost 4.4% over five years, while fixed rate loans will be slightly higher at 4.5%.

Both scenarios are about two percentage points higher than what is available on the market today.

Under this scenario, the 1.4 million Canadians who obtained a mortgage in 2020 or 2021 would see their median monthly cost increase by $420, or 30% at renewal.

The impact on fixed-rate borrowers would be slightly less, as they would see their payments increase from an average of $1,260 when obtaining their first loan to $1,560 per month upon renewal, an increase of 24% .

But variable-rate borrowers are even more vulnerable, according to the bank’s think tank, as their typical monthly payments jump from $1,650 a month when they first got their loan to $2,370 upon renewal. That’s a 44 percent increase.

“If members of highly indebted households lose their jobs, they will likely have to cut spending significantly to continue paying their mortgages,” Macklem said.

“It’s not what we expect, but it’s a vulnerability to watch closely and manage with care,” Macklem said.

Other risks beyond housing

Vulnerability to the housing market was only part of the Financial System Review, which is the bank’s overall assessment of the health of the economy and its ability to withstand various shocks.

Some of the other vulnerabilities cited include cyber threats given the interconnected nature of the financial system and the fragile liquidity of fixed income markets.

The bank also warned against the growth of cryptocurrencies and their volatility.

“Like other speculative assets, cryptocurrencies are vulnerable to large and sudden price declines. And recently, some stablecoins have failed to live up to their promise of stability,” Deputy Governor Carolyn Roger said.

The bank also says that Russia’s invasion of Ukraine has further complicated the transition to a low-carbon economy and that assets exposed to the fossil fuel sector, such as those found in pensions and the retirement savings of many Canadians, are more likely to be worth much less than expected.