Canada’s housing market may not be as risky as the IMF thinks

But a quick review of the state of housing markets and borrowers in Canada presents a stable and even improving picture of risk metrics, which makes us wonder what led to such an alarm by the IMF, which is the lender of last resort for many struggling nations.

The central bank said it is cognizant of the “elevated level of household indebtedness and high house prices,” so keeping a close watch on the movement of risk metrics is essential. But a review of those metrics suggests the increase in financial vulnerabilities might have more to do with rising interest rates than rising housing prices. Also, some risk indicators suggest an improvement over time rather than a decline.

One improving indicator is the number and quality of new mortgages being issued. Mortgage origination peaked in the first quarter of 2021 after rising rapidly from the second quarter of 2020. Whereas housing prices continued their upward climb during 2021, mortgage originations declined to 132,672 in the first quarter of 2023 from a peak of 282,272 in the first quarter of 2021.

Another risk metric moving in the right direction is the share of new mortgages with a loan-to-income (LTI) ratio of more than 450 per cent, a proxy for high-risk mortgages. High LTI mortgages peaked in the first quarter of 2022, but have declined to pre-pandemic levels since then. Investors constitute the smallest segment of high LTI borrowers, much lower than first-time and repeat homebuyers.

The loan-to-(housing)-value ratio (LTV) is another indicator for high-risk homebuyer borrowers, who borrow up to 95 per cent of the dwelling value. The higher the LTV, the higher the risk. The share of high LTV new mortgages has been declining since 2020, such that less than five per cent of new mortgage originations in the first quarter of 2023 had an LTV of 95 per cent or higher.

Some risk metrics, however, have recently worsened. For example, the share of household income dedicated to new mortgage debt has sharply increased since early 2022.

But this metric — also known as the debt-service ratio (DSR) — has more to do with rising interest rates than accelerating housing prices. The DSR remained stable (and even declined for first-time homebuyers) even as housing prices rapidly grew from 2014 to 2021.

Another worsening indicator is the share of indebted households behind in payments for at least 60 days, which increased to 2.28 per cent in the first quarter of 2023 from a little less than two per cent in the third quarter of 2021.

But we’re not panicking about this data for two reasons. First, the increase of 0.41 percentage points is concerning but not alarming. Second, the current rate of mortgage loan arrears is 0.12 per cent, the lowest since 2014. The rise in arrears, albeit small, is due to instalment loans that are not necessarily tied to housing markets.

Since the onset of the pandemic, the share of homes bought by investors has increased to 27 per cent from 22 per cent. Some find this concerning, but we think otherwise. Investor borrowers rank lower on risk metrics, such as LTV and LTI ratios, than first-time or repeat homebuyers. Growth in the number and share of highly leveraged borrowers is unlikely to improve overall risk indicators.

The Bank of Canada’s picture presents a reassuring image of household balance sheets and how Canadians manage and service debt. So, what made Canada the riskiest housing market in IMF’s assessment?

Simply put, the IMF analysis is not a product of advanced macro-econometric research, which the institution is known for. Instead, it undertook a ranking and colouring exercise to present a chart that relied more on crayons than analytics.

A prudent approach for borrowers and lenders is not to overextend and to be mindful of unexpected income disruptions resulting from job losses. Debt is, after all, a four-letter word, so relying on it requires extreme caution.