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The Bank of Canada says it is concerned about rapidly rising home prices and mortgage debt in its financial system review.
"Many households have taken on large mortgages compared with their income, so have less flexibility to deal with unexpected events like the loss of a job," said the Bank of Canada in the review.
Canada's central bank is also concerned about the quality of mortgages. It says households stashed away cash during the pandemic and had limited opportunities to spend it. As a result, they took on more mortgage debt. But more of those mortgages were issued with elevated loan-to-income ratios.
The last time quality deteriorated to this level, regulators stepped in with new rules.
"The quality of new mortgage borrowing deteriorated during the pandemic. The share of newly issued mortgages with a loan-to-income (LTI) ratio above 450 per cent rose substantially in the second half of 2020," said the Bank of Canada.
"At 22 per cent of all mortgages, this share is now above the range seen in 2016–17, before the Office of the Superintendent of Financial Institutions (OSFI) introduced the revised Guideline B-20."
With that said, the Bank of Canada says signs of personal bankruptcies are low, mainly because of exceptional government support.
It also says a lack of homes for sale and strong demand are leading to rapidly rising home prices, adding that this is leading to Canadians buying because they expect prices to keep going up, which comes with its own risks.
"If house prices and household incomes were to fall in the future because of a shock to the economy, some households could need to cut back on spending. This would slow the economy and possibly put stress on the financial system."
The Greater Toronto Area, Hamilton and Montréal were singled out as displaying extrapolative expectations, with Ottawa on the cusp.
Don't count on ever-rising house prices
During a press conference, Bank of Canada Governor Tiff Macklem warned potential buyers about expecting house prices to keep rising.
“Canadians need to be prudent in taking on more debt. It’s important to understand that the recent rapid increases in home prices are not normal," said Macklem.
“Interest rates are unusually low, borrowers and lenders both have a role in ensuring that households can still afford to service their debt at higher rates. Counting on ever-higher house prices to build home equity that can be used to refinance mortgages in the future is a bad idea."
When asked if the Bank of Canada is responsible for the rise in home prices, Macklem said low rates are part of it.
"This is largely driven by fundamental demand. We’re all spending more time at home, Canadians want more space," said Macklem.
Macklem also said he gets letters from Canadians who are concerned about real estate.
"We are acutely aware that this housing market is really making it difficult for some Canadians to get into the housing market."
Although he says he sees some signs of speculative flipping, Macklem says there aren't as many as the last big bull run in 2016.
Jessy Bains is a senior reporter at Yahoo Finance Canada. Follow him on Twitter @jessysbains.