Evidence that Canada’s housing market is cooling has been 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, the widening of mortgage spreads and news that a lender has suspended new loan applications has prompted Capital Economics to deepen its forecast of home price declines to 20%.
Mortgage spreads dropped during the pandemic when 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 the policy rate jumped by 50 bp to 170.
This month too Magenta Capital Corporation, one of Canada’s largest private lenders, decided to temporarily halt new loan applications until September. Although Magenta accounts for only a small portion of total lending, it is a big player in the subprime market, says Capital, and its decision may only be the beginning.
“There will be so many more of these Mortgage Investment Corps suspending lending in the next eight weeks,” said Ron Butler, of Butler Mortgage, in a tweet after the news. “When your modelling suddenly shows values dropping 5% a month in some markets, what else can you do?”
As financing dries up, the risk of forced home sales rises, “something Canada’s housing market has historically avoided,” said Capital economist Stephen Brown.
On the bright side, Capital believes the situation is not quite as dire as some recent headlines might suggest.
Only 3% of homeowners in Canada with a variable rate mortgage with variable payments would face immediate pressure to sell as rates rise further, said Brown. 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.
Nor did May’s data show evidence of forced selling. New listings rose by 4.5% from the month before but were lower than in February.
But what the surge in mortgage rates has caused is a “huge hit to buying power,” said Capital.
Home sales were down 22% in May from the year before and that was 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 round to our view 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. Accordingly, we are revising down our forecast for house prices to a 20% fall,” wrote Brown.