The housing market in much of Canada is on fire right now, most notably in the country’s major hub cities like Vancouver and Toronto, where the price of a detached home averages well over $1.0 million.
But, as the Canada Mortgage and Housing Corporation (CMHC) demonstrates, that craze is by no means permanent, nor impervious to derailment. The CMHC found that a sudden rise in interest rates could cause house prices to plunge by an average of 30% nationally.
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The CMHC runs multiple “what-if” scenarios in order to stress test the system. During one such projection, the organization found that a one percentage-point increase over one quarter year in 2016, followed by a 1.4-percentage point rise during a quarter next year would cause $1.14 billion in losses for its mortgage insurance business. It did, however, claim that it could withstand the hit.
A spokesperson called the scenario an “extreme case” as reported by The Canadian Press. (Source: “What would a sudden interest rate increase mean for house prices?,” Macleans, November 17, 2016.)
Interest rates are already on their way up this week as a sell-off in the U.S. bond market has pushed bond yields higher, creating a less favorable situation for banks to access capital.
Both Toronto-Dominion Bank (TSE:TD) and Royal Bank of Canada (TSE:RY) have raised their fixed mortgage rates, anywhere from 0.05% to 0.4%.
And just to be sure that it had all its bases covered, CMHC ran a few other worst-case scenarios for the period of 2017-2021. For instance, a U.S.-style housing correction, a high-magnitude earthquake that devastates a major Canadian city, and a drop in oil prices where they fall to US$20 a barrel and hover at that cost for the next four years.
As for CMHC, they said that they have sufficient capital holdings to withstand each and every one of these potential catastrophes.
But at the end of the day, this provides a clear picture of the potential fragility of the housing market in Canada. While there are gains to be had the country over, there’s inherent risk that a few quirks of fate could see value drop, and quite drastically at that.
