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Addiction to debt adds risk to real estate market

They are under 35, heavily indebted and own homes with relatively large mortgages and longer amortization periods. Also, they are readily found in Toronto or Vancouver.

A recent report by the Bank of Canada identifies the at-risk borrowers who are more vulnerable to economic shocks, such as a sudden loss in income or a rapid increase in mortgage rates. The highly indebted young borrowers have low-ratio mortgages, which are usually uninsured and have loan-to-value ratios below the 80 per cent threshold. But that’s of little comfort: Their mortgage credit is large relative to their incomes, with loan-to-income ratios more than 450 per cent.

Starting Jan. 1, 2018, the minimum qualifying rate for uninsured mortgages will increase by the greater of the Bank of Canada’s five-year benchmark rate or 200 basis points (2 per cent) above the contractual mortgage rate. Realizing the large increase in uninsured mortgages in Toronto and Vancouver, OSFI, the federal regulator, has tightened regulations for the uninsured mortgages bringing them in line with the insured mortgages.

Given the limited success of previous interventions in arresting the sustained increase in housing prices and household debt, will the new measures achieve the intended objectives?

A series of regulatory changes to arrest the climbing housing prices has had the expected result of a moderate to severe reduction in sales and prices in some large urban markets. Still, concerns about the rising household debt in Canada persist with Canadian households now being the most indebted among the OECD countries such that the average Canadian household debt is more than 100 per cent of per-capita GDP.

The higher qualifying rate is likely to lower the size of mortgage loans that will be approved for most borrowers. As a result, some borrowers might postpone purchasing a house. At the same time, some potential sellers might unlist their properties if they see prices dropping. A report by the Fraser Institute warned of negative impacts on mortgage markets “including higher loan pricing and reduced loan access for some consumers.”

The more stringent mortgage regulations announced by OSFI apply to federally regulated financial institutions that also include all major banks in Canada. OSFI further requires lenders to adhere to stipulations for loan-to-value ratios intended to limit the size of loans relative to the value of the property.

Despite the tightening of regulations by federal and provincial governments, housing markets and borrowers in Canada refuse to budge and are still eager to enter the marketplace. The 15 per cent tax on foreign buyers in British Columbia and Ontario had an initial impact on housing sales and prices in the Greater Vancouver and Greater Toronto markets. However, markets are rebounding in Vancouver, and early signs of a recovery can be seen in Toronto.

Higher household debt in Canada is likely a result of historically low-interest rates that have lasted over a long period of time. Given the favourable interest rates, even Canadian governments could not resist the temptation to borrow. The billions of dollars being spent on infrastructure construction and renewal across Canada are financed by debt.

The question is how big a challenge the rising household debt in the short run (and the public debt in the long run) pose to the financial stability of Canadian markets. As we have mentioned earlier, prior attempts to limit household borrowing have met with little success. Regulators had previously tightened rules for insured residential mortgages, which accounted for 54 per cent of the $1.46 trillion mortgage credit. Similar stringent regulations will now be extended to the uninsured mortgages, which are estimated at $666 billion.

Already, some housing market specialists have pointed out the gaps in the planned regulatory changes, which apply only to federally regulated lenders. Exempted are the provincially regulated lenders including credit unions and caisses populaires who are also active in the mortgage market and account for 17 per cent of the mortgage lending in the uninsured segment.

It is likely that the new regulations will shift some mortgage lending from federally regulated institutions to others. The Bank of Canada continues to list elevated levels of household debt and imbalances in housing markets among the top sources of vulnerability. An effective response to vulnerabilities must not be compromised by jurisdictional gaps. The time for uniform regulations that apply to all lenders is now.

Murtaza Haider is an associate professor at Ryerson University. Stephen Moranis is a real estate industry veteran. They can be reached at