Canada’s housing market cooling but economists see ‘worried’ signs

Canada’s housing market cooling but economists see ‘worried’ signs

Evidence that Canada's housing market is cooling is obvious for several months, but now some economists say signs are appearing that the reckoning will be worse than they had feared.

An increasingly hawkish Bank of Canada, a widening of mortgage spreads and the news that a lender has suspended new loan applications has prompted Capital Economics to deepen its home price declines to 20%.

During the Pandemic, mortgage spreads dropped and lenders were eager to offer homebuyers financing, but this trend has reversed in recent months.

Capital says the spread between the discretionary five-year fixed mortgage rate, or the average for uninsured borrowers, and the five-year swap rate doubled from its October 2021 low of 60 basis points to 120. The spread between variable rates and policy rate went up by 50 bp to 170.

This month, Magenta Capital CorporationCapital Corporation, one of Canada's largest private lenders, temporarily halted new loan applications until September. According to Capital, Magenta is a big player in the subprime market and may only be the beginning, as it accounts for only a small portion of total lending.

As financing dries up, the risk of forced home sales rises, something Canada's housing market has historically avoided, said Stephen Brown, Capital economist.

Capital believes that the situation is not quite as dire as some recent headlines might suggest.

Brown said that only 3% of homeowners in Canada with a variable rate mortgage with variable payments would face immediate pressure to sell as rates went up further. Some will have to renew at a higher rate this year, but considering rates five years ago were close to a peak, they should be manageable for most.

May's data shows no evidence of forced selling. The new listings rose by 4.5% from the month before, but were lower than in February.

Capital said that the surge in mortgage rates has caused a huge hit to buying power.

In May, home sales were down 22% from the year before, when the five-year fixed mortgage rate was 100 bps lower than the current 5.1%.

While we expect fixed mortgage rates to drop back as markets come around to our belief that the policy rate will peak at 3.0%, rather than 3.75% as market pricing now implies, much of the damage has already been done. Brown wrote that we are revising down our forecast for house prices to a 20% fall.