The steady climb in housing prices over the past decade has made it easier for Canadians to borrow against the value of their homes, leaving many families vulnerable to “a significant shock” if prices were to snap back, the Bank of Canada is warning.
Governor Mark Carney and his policy team have long pointed to record levels of household debt as the chief domestic risk to the financial system and the wider economy, urging borrowers to resist the lure of ultra-low mortgages unless they can afford them once rates inch up.
In a series of research papers published Thursday, the central bank shows much of the growth in debt has come from a surge in home-equity lines of credit, which allow homeowners to finance renovations and other spending at reasonable rates. While this may be a predictable result of a long stretch of low borrowing costs, the central bank warned that it means a swift reversal in home prices could have a “relatively large impact” on consumer spending.
“A fall in house prices decreases the value of collateral held by households, leading to a deterioration in the state of household balance sheets,” the central bank said, noting that many families “could therefore experience a significant shock if house prices were to reverse.”
The research papers do not include policy prescriptions, but they underscore concerns about the ability of some consumers to keep spending at a time when Mr. Carney and his officials are counting on domestic purchases to power the economy amid slower demand for exports.
In one paper, the central bank says loans backed by homes made up almost 50 per cent of all consumer credit last year, compared with 11 per cent in 1995. In another, a simulation indicates a 10-per-cent drop in home prices could translate into a 1-per-cent decline in consumption.
Mr. Carney, whose next interest rate decision is on March 8, has shown increasing discomfort with the effects of his low borrowing costs on some households’ spending, but the shaky economic climate has kept him from tightening policy.
Finance Minister Jim Flaherty, meanwhile, said on Thursday in Toronto that authorities are keeping an eye on the hot condominium market in some cities, and urged borrowers to resist buying “the most expensive house they can possibly buy.” At the same time, he said he is encouraged by “some moderation of late” in Canadians’ borrowing.
The central bank noted in its research that while income and population growth account for some of the gains in house prices over the past 30 years, more recently other variables have played roles, such as low mortgage rates and unrealistic expectations that prices will keep rising.
Also, the bank published data showing that younger Canadians are more debt-strapped than Canadians of the same age were just over a decade earlier: In 2010, the mean after-inflation debt load of a typical household led by people aged 31-35 was $120,000, up from $75,000 in 1999.
“Given the increase in household indebtedness, the exposure of households and the financial system to fluctuations in house prices has increased markedly,” the bank said.
Still, the bank was careful to add that Canada’s housing market has not yet shown signs of “the excesses seen in other countries,” such as the United States, where the subprime mortgage market imploded in 2008, triggering the global financial crisis.
Most economists say that while Canadian home prices are poised to stabilize, a backward correction or outright crash does not appear likely.
“The idea [of the research papers]is if there is a negative hit to home prices, let’s say a U.S.-style shock and decline, then that would have a significant negative impact on the economy, and for households,” said David Onyett-Jeffries, an economist with Royal Bank of Canada. “However, they don’t necessarily view that such a shock in housing is likely to occur.”
With a file from reporter Bill Curry in Ottawa