House-price plunge feared if rates surge

TORONTO — A sudden rise in interest rates could cause house prices to plummet on average 30 per cent nationally, according to stress tests performed by Canada’s federal housing agency released Thursday.

Canada Mortgage and Housing Corp. said it studied the impact of two interest-rate hikes — a one-percentage-point increase over one quarter this year, followed by a 1.4-percentage-point rise during one quarter next year.

CMHC said its mortgage insurance business would incur $1.13 billion in losses in such an event but that it could withstand the hit. A spokesman for the agency stressed that the scenario is an “extreme case” and would be unprecedented.

Interest rates started to go up this week as a selloff in the U.S. bond market has driven bond yields higher, making it expensive for banks to access capital.

Two of Canada’s biggest banks — TD Bank and Royal Bank — have hiked fixed mortgage rates, anywhere from 0.05 percentage points to 0.4 percentage points.

There are concerns that as interest rates rise, some Canadian homeowners could encounter difficulty making their mortgage payments and face the risk of default.

“Households are so leveraged right now and house prices are at such incredibly high levels relative to household incomes,” said David Madani, senior Canada economist at Capital Economics.

“Even a moderate doubling in interest rates — which sounds like a lot but we’re talking about maybe 200 basis points [two percentage points] — could potentially pop the housing bubble.”

Interest rates have been trending lower for more than a decade, but that has not always been the case.

Fuelled by inflation, mortgage rates soared in the 1980s and posted five-year fixed rates topping more than 20 per cent in 1981.

According to data kept by the Bank of Canada, the posted fiveyear rate for a conventional mortgage at the big Canadian banks climbed from 13.25 per cent in January 1980 to 16.75 per cent in April 1980, an increase of 3.5 percentage points. However, Canada started using an inflation target to guide monetary policy in 1991, and since then inflation has been mostly tamed and interest rates have fallen.

The stress test was one of several extreme scenarios examined from 2017-2021. They included a U.S.-style housing correction, a high-magnitude earthquake that destroys critical infrastructure and a drop in oil prices where they fall to $20 US per barrel next year and remain between $20-30 for another four years.

Another scenario the agency tested involved a “severe and prolonged” economic depression, which would see house prices drop 25 per cent and unemployment rise to 13.5 per cent.