Canada may need tougher lending rules to guard against the risks from a higher proportion of borrowers facing deep debts, economists at the C.D. Howe Institute said.
Mortgage debt was at least 500 percent of disposable income in 10.8 percent of households in 2012, up from 3.4 percent of households in 1999, according to a paper published Wednesday by the Toronto-based research group. The combination of low interest rates and a 158 percent jump in home resale prices since 1999 inflated mortgage debt to C$1.2 trillion ($900 million) in 2014, with vulnerable groups among young families and those in expensive markets such as Vancouver and Toronto, the report found.
“There are significant pockets of vulnerability created by the growth in mortgage debt in recent years,” according to Craig Alexander, a C.D. Howe researcher and former chief economist at Toronto Dominion Bank, and Paul Jacobson, president of the Canadian Association for Business Economics. “The majority of Canadians have been responsible in their borrowing, but the sustained low interest rate environment has encouraged a significant minority to take on considerably more mortgage debt relative to after-tax income.”
New Finance Minister Bill Morneau, who was chairman of C.D. Howe before entering politics, has said housing is one of the first briefings he took from his officials. Canada has long faced international warnings about the need to head off a housing crash like those seen in the U.S., the U.K. and Spain, and former Finance Minister Jim Flaherty
acted several times to tighten lending rules.
Putting in new restrictions is difficult because those past changes have already slowed credit growth, and because the risks now are in a few segments of the market that make using a “blunt tool” approach counter-productive, the authors said.
Policy makers could set tougher underwriting rules on criteria such as credit scores and debt-service ratios, or raise the interest rate that tests a borrower’s ability to pay up later, Alexander and Jacobson wrote.
One tool to target Vancouver and Toronto would be raising the down payment requirement on more expensive homes, the report said. That echoes a proposal the finance department has been making this year, according to people familiar with those talks.
No matter what happens, the new reality of housing debt will influence Bank of Canada Governor Stephen Poloz when he moves to raise his 0.5 percent policy interest rate. “Every quarter point rise in interest rates in the future will have a much bigger impact on household finances than in the past,” the report said.
“The pace of tightening may need to be very gradual to limit the economic and financial risks,” the authors said. “It should also look to raise interest rates when appropriate to reduce the incentive for households to take on higher debt loads.”