Before bidding for a house, heed alarms bells rung by central bank

June 24, 2021 10:23 AM CEST | By Team Kalkine Media
 Before bidding for a house, heed alarms bells rung by central bank
Image source: Pixabay.com

Summary

  • Rise in housing prices fueled by cheap debt and mismatch in demand and supply.
  • High level of Canadian household debt due surging mortgage payouts a concern.
  • Treating any sector as a quick multiplier of wealth can lead to broader repercussions.

In its 2021 Financial System Review, the Bank of Canada elaborated on how Canadians managed last year exceptionally well despite the economic upheaval brought by the pandemic. People could service their debt obligations, rack up savings, and steer clear of personal bankruptcies.

The central bank’s statement is accompanied by the role played by the government’s financial support to households. In the same breath, it also warns of risks arising from an earlier-than-expected hike in benchmark rate and an early end of government support to businesses and households. A severe pandemic in the near future and geopolitical tensions can add to the vulnerabilities of the country’s financial system, thereby impacting the financial health of Canadian households. As highlighted by the central bank, an unforeseen surge in house price is adding to Canadians’ indebtedness.

In May 2021, the MLS Home Price Index (HPI), which tracks the median change in housing prices across Canada, was up 24.4 per cent compared year-over-year (YoY). The rise is the highest-ever despite May being the second month in a row when the number of houses resold declined. This is because there are fewer sellers, which reflects in the low number of listings in May. It validates the rising prices due to the mismatch of demand and supply.

RBC cautions against rising mortgage payments

On a separate note, the Royal Bank of Canada (TSX:RY) has warned that more Canadians are feeling the price pressure and owning a home is now a ‘distant dream’. The top lender added that measures like tightening mortgage stress tests are of little help in dissuading buyers. From June, the qualifying rate is 5.25 per cent compared with the previous 4.79 per cent. Other measures, including first-time buyer incentives and GST rebate, have also contributed to higher demand. The tax on vacant homes, as announced in the Federal Budget 2021, are yet to be implemented.

According to the RBC, prices will be up 13 per cent YoY this year, and sales will be up 16 per cent YoY. For 2022, it expects sales to decline from current year levels, but prices will still be up 3.3 per cent.

Amidst this, Canadian households’ debt level owing to surging mortgage payouts remain a concern. Last year, mortgage payments for a standard house shot up to C$2,500 per month - an increase of C$330 since the onset of the pandemic. Over the next 12 months, it could rise by another C$150, given the current trend in price gains.

Cheap debt fueling housing growth

Copyright © Kalkine Image 2021

Canadians have enough spare cash to outbid other buyers in the housing market, thanks to the government’s pandemic support. Mortgage debt is available at cheap rates since last year when the Bank of Canada slashed the policy rate to 0.25 per cent. In his recent statement, BoC governor Tiff Macklem indicated that low rates would stay at least until the second half of 2022, which is when it expects the turmoil brought by the pandemic to recede completely. The governor also accepted that although there are some signs of the housing market stabilizing over the past two months, any normality in the market is still far-fetched.

The central bank’s recent statement in the Financial System Review, ‘household vulnerabilities have intensified’ is worrying. It specifically warned that servicing the debt will be a challenge in the event of job losses. Moreover, any further unexpected shock can result in the repricing of houses, and all price gains last year can be wiped out in no time. Any such event may negatively impact the country’s financial system owing to Canadians scaling back their spending, anticipated the central bank.

Too much mortgage debt can be onerous

Treating any sector as a quick multiplier of wealth can lead to broader repercussions. Governor Macklem admits more Canadians are parking wealth in housing assets in hopes of price gains. But what will happen if there is no considerable improvement in the unemployment level, which is currently at 8.2 per cent, and if government support is withdrawn sooner than expected?

In the US, the Fed has lately indicated that the policy rate can be hiked by 2023, given the inflationary pressures. In Brazil, the central bank has already begun rate hikes to nip inflationary pressures in the bud.

With a sudden rise in prices comes a warning of a correction. Be it the stock market or new investment alternatives such as digital currencies, any sudden spike in values can owe more to speculation than any concrete fundamental. The wealth parked in housing assets with a growth goal in the near term will depend on how the broader economy reacts to yet-unclear economic fundamentals.

Before making an investment decision and bidding on a house in the current setting, please heed the warnings of central banks.


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