Recently the provincial government in Ontario and Canada’s federal government implemented housing policies designed to slow down the housing market in the Greater Toronto Area and put the brakes on climbing levels of household debt. The measures have worked, at least in the short term, as the real estate market in Toronto took a breather.
But a proposal by the federal regulator of financial institutions would require that anyone applying for a mortgage would have to pass a “stress test” of 200 basis points over their qualifying rate before they could be approved. Currently this rule applies only to those who apply for insured mortgages (with a down payment of less than 20 per cent). Critics say this is an over-reaction and could put the country’s economy in jeopardy.
Despite record levels of household debt in Canada, most people are handling it well, particularly those who have a mortgage. The Canadian Bankers Association says the percentage of mortgages that were in arrears as of April 30 of this year was 0.26 per cent.
Canada Mortgage and Housing Corp. (CMHC) reports that in the fourth quarter of last year, there was a drop in the delinquency rate for all types of loans. “The average credit scores of mortgage holders improved in the fourth quarter, in addition to a decrease in their likelihood of bankruptcy,” says the CMHC report. “In contrast, consumers without a mortgage continued to follow a declining trend in their average credit scores beginning in 2015, as well as an increasing likelihood of bankruptcy.”
The agency says the number of mortgages that are 60 to 90 days past due dropped, which “bodes well for the next quarters as fewer loans are showing early signs of difficulty.”
A recent report says, “Canadians are regularly inundated with news stories about policy concerns over household debt. These concerns, however, can be seen to be overblown once we properly account for the other side of the balance sheet.”
The report, by Livio Di Matteo, a senior fellow at the Fraser Institute and Professor of Economics at Lakehead University in Thunder Bay, Ont., says, “Debt is a tool and the concern should not be with debt itself but debt that is not manageable in the economic circumstances facing households and government. The greatest risk to the management of household credit-market debt are economic shocks that lead to job losses that make debt servicing difficult, or increases in the interest rate that raise debt-servicing costs. To date, interest rates have remained low and the Canadian economy has performed adequately, with relatively low unemployment rates.”
The Bank of Canada recently raised interest rates for the first time in seven years. More small increases are expected.
“It is quite possible that interest rates will increase to some degree over the coming years, but it seems unlikely that interest rates will increase to the level assumed by the stress test,” says Will Dunning, an economist with Mortgage Professionals Canada, a mortgage brokers’ association. “On the other hand, if the stress test policy works as intended and reduces homebuying, it would weaken the Canadian economy.”
Dunning says most people would be able to cope with an increase in mortgage rates by extending the amortization periods of their loans. “It would take them longer than hoped-for to repay their mortgages, but at least they could stay in their homes, and continue to retire their mortgages. Meanwhile, they will have been able to meet their own housing needs. On the other hand, if the stress test does achieve its intended consequences, it will unnecessarily prevent them from meeting their own legitimate needs at costs that they can afford,” Dunning says.
“The bottom line is obvious. The government should not be pursuing a policy which, if it works as intended, will impair the Canadian economy.”
If government policies result in a decline in house prices, he says the entire country would be impacted, not just Toronto and Vancouver.
“The initial negative effects would emerge in communities that are already weak economically and have weak housing markets, and their reductions in spending would spread their pain across the country. The housing market data we have now hints that this initial, localized pain may be present in some areas of the country.”
Another economist urging caution is Benjamin Tal of CIBC Economics. He says higher interest rates are “unlikely to lead to a surge in default” but they will slow the pace of mortgage originations.
“The proposed changes to apply a 200-basis point increase to the qualifying rate of the non-insured mortgage segment of the market could be more significant,” Tal says. “We estimate that such a move, if implemented, could cut growth in mortgage outstanding by two percentage points from the current six per cent annual growth. Add to it the possibility of a reduced average size of mortgage due to lower house prices and it’s not unreasonable to assume that within a year or two mortgage growth in Canada would be half of what it is now.”
Tal says, “Too severe rate-induced slowing in consumer spending and real estate activity could be recessionary and eventually turn the growth story into a credit quality story.”
Di Matteo says that “despite the high levels of household debt, there are also record high levels of net worth,” much of it in real estate. He says that could be a concern if there’s a significant housing correction, particularly in Vancouver and Toronto where house prices have soared in recent years.
A decision on whether the new stress test guidelines will go ahead is expected late in 2017.
