Mortgage tests tighten amid central bank warning

Canadians looking to buy homes will face stiffer mortgage tests in a few days as the federal government and a national regulator tighten rules in the wake of new warnings from the central bank that households are piling on too much debt.

In its latest financial system review, the Bank of Canada said many households have taken on large mortgages compared with their income, limiting their flexibility to deal with an unforeseen financial shock like the loss of a job.

Total household debt has increased by four per cent since the start of the pandemic, picking up sharply since the middle of last year as the housing market started to heat up. The percentage of costly loans, defined by the bank as those more than 4.5-times a household's income, have also risen above the peaks seen five years ago when policy-makers tightened mortgage rules.

The bank's report said that the activity in the housing market and troubling figures on mortgages is reminiscent of 2016 just before stress tests were brought in on mortgage applications to make sure buyers could handle payments if interest rates rose.

The Office of the Superintendent of Financial Institutions said Thursday that effective June 1, the qualifying rate on uninsured mortgages would be set at either two percentage points above the contract rate, or 5.25 per cent, whichever is greater.

Hours later, the federal government, which had been pressed to follow suit, announced it would set the same standard for insured mortgages on the same day, effectively trying to prepare buyers for when interest rates rise from their current lows.

“The recent and rapid rise in housing prices is squeezing middle-class Canadians across the entire country and raises concerns about the stability of the overall market," Finance Minister Chrystia Freeland said in a statement accompanying the announcement.

"Maintaining the health and stability of Canada’s housing market is essential to protecting middle-class families and to Canada’s broader economic recovery."

In its report, the Bank of Canada said the current housing boom may help the economy rebound in the short-term, but could lead to a future bust if households have to cut spending because of another downturn.

And by biting off more than they can chew with a new mortgage, governor Tiff Macklem warned it may make those households more vulnerable to rising interest rates when it comes time to renew their loans, adding it was up to Canadians and lenders to be prudent.

"The current rapid increases we've seen in prices — don't expect that those will continue indefinitely," Macklem told a news conference.

"Don't expect that you can pull equity out and refinance your mortgage in the future on the basis that prices are going to continue to go up like we've seen."

House prices were up 23 per cent nationally relative to a year earlier, the bank said in its report. The Canadian Real Estate Association said this week that the average price of a home sold in Canada in April was just under $696,000.

The bank said the surge in prices is more widespread in cities than five years ago, when things were largely concentrated in and around Toronto and Vancouver. In the bank's view, the Greater Toronto Area, Hamilton and Montreal are overheated and Ottawa is on the precipice of joining them.

With house prices rising, and supply of available homes lagging demand, some homeowners may be tempted to buy now out of concern that they won't be able to afford something in the future.

The Bank of Canada's hands appear to be tied on its ability to raise its trend-setting policy rate that could pour cold water on anyone wanting to buy right now. Macklem said swaths of the economy still need central bank support and the labour market needs to add some 700,000 jobs to get the employment rate to where it needs to be before rates could rise.

The review of the risks to the financial system also highlighted concerns about a too-soon withdrawal of government aid for businesses. Companies are concerned about their future viability when government support ends because much remains uncertain about what post-pandemic life and economic activity will look like, the central bank said.

For banks and insurance companies, the Bank of Canada said cybersecurity remains one of their top concerns.