BOC highlights risk of bank sector stresses, high household debt
The Bank of Canada is more concerned than it was a year ago about the risks posed by high household debt to the Canadian financial system as higher interest rates increase the cost of mortgages, according to its latest financial system review.
Higher borrowing costs mean more households are expected to face financial pressure in the coming years and a decline in housing prices has reduced homeowner equity, according to the annual report published Thursday.
The bank said many Canadians have less financial flexibility after stretching their budgets to get into the housing market by taking on large mortgages with lengthy amortization periods.
“A longer amortization period reduces the size of monthly payments, helping lower debt-servicing costs, but increases the period of household vulnerability because equity is built more slowly,” the bank stated.
A severe global recession that causes housing prices to fall further could lead to more loan defaults, it said. As Canadian banks hold a high share of uninsured mortgages on their balance sheets, this could result in sizable credit losses if defaults were to occur on a large scale.
“While most households are proving resilient to increases in debt-servicing costs, early signs of financial stress are emerging,” the review stated. “High debt-servicing costs and low homeowner equity make households more vulnerable to default if they experience a drop in income. A severe recession with significant unemployment could lead to more defaults and therefore credit losses for lenders. ”
While about one-third of mortgages have seen an increase in payments compared with February 2022, just before the Bank of Canada's recent rate hiking campaign, nearly all borrowers are expected to face higher payments by 2026.
Mortgage payments could spike as much as 40 per cent in three years for those on variable-rate mortgages with fixed payments, while those with fixed-rate mortgages could see their payments increase by 20 to 25 per cent over 2022 levels.