It has been widely reported that Canada could potentially experience a major mortgage crisis in the near future. In recent years, mortgage debt in Canada has been steadily increasing. At the same time, increasing real estate prices, a weaker Canadian dollar, and regulations changes from the federal government have also contributed to the situation. This has led the Canadian banking industry to take a proactive stance in order to prevent a looming financial crisis.
Mortgage debt in Canada has surpassed pre-recession levels; in January 2018, the average Canadian carried a total of $195,752 in mortgage debt. This number has increased significantly since the 1990s. As a result, approximately one in three Canadian households are now over-indebted, which means that they have more debt than they can handle.
The primary cause of this excessive debt is the dramatic increase in home prices in recent years. In the last ten years alone, the average house price in Canada has more than doubled from $323,000 to $644,000. This has resulted in more people being unable to afford the cost of a home and opting for a mortgage instead.
At the same time, residential mortgages have become increasingly available. Lenders are now offering products such as longer loan terms, lower-down payments, interest-only payments, and alternative lenders who are willing to take on riskier borrowers. This accessibility to credit has allowed Canadians to purchase homes with a greater loan-to-value ratio, thus escalating the debt levels even further.
The Bank of Canada has responded by raising interest rates in order to undermine the long-term sustainability of these mortgages. In the past, a five-year fixed mortgage rate in Canada had averaged at around 4.69%. This number was recently bumped up to 5.34% in 2018 to reduce economic stimulus and slow the rise of real estate prices. This will help to manage the current deficit and return Canada to a more sustainable economic state.
Despite these measures, it is still possible that a mortgage crisis will impact Canada’s credit markets. In a scenario where house prices were to drop, mortgage lenders would be left carrying the burden of over-leveraged investment properties. As a result, banks would be unable to collect their loans, and unpaid mortgages could become large financial losses for the lender, ultimately destabilizing the financial sector.
To prevent this outcome, the Canadian banking industry has been introducing stricter lending rules, while at the same time providing financial relief options for households that are facing financial hardship. These measures have been meant to reduce default rates and minimize the severity of any potential crisis.
One measure introduced by certain banks is to offer stress-testing, or a rigid examination of a customer’s ability to handle fluctuations in their payments. This includes the mandatory application of the Bank of Canada’s posted rate regardless of the contractual rate on the loan. Additionally, some lenders are now offering shorter amortization periods as well as increased credit inquiries at the start of the loan process. This has been seen as an effective way of reducing the overall risk for consolidation mortgages.
In addition, the Canadian banking sector has brought in measures aimed at helping struggling customers. These include loan restructuring and deferral programs which give customers the ability to adjust their payments towards their overall debt. Banks are also offering loan modifications which allows customers to reset their mortgage terms in order to better align with their financial circumstances.
The Bank of Canada, on the other hand, has outlined parameters for lenders and borrowers to ensure that looser credit markets are not abused by investors more interested in gaining access to increased risk than long-term financial stability. This includes the introduction of a mortgage stress test for anyone seeking an uninsured residential mortgage with a loan-to-value ratio of 80 per cent or higher, and the maximum amount one can borrow repayment-free for five-year fixed-rate terms has also been reduced from 65 per cent to 45 per cent.
To conclude, while it is not easy to determine whether or not Canada could be headed towards a mortgage crisis, the proactive measures taken by the banking industry should – in part – mitigate any potential damage should a crisis were to occur. Canadians are living with an ever-increasing debt burden, and the financial sector is attempting to cope before it becomes a major issue.