The days of Canada having a reputation of conservative bank practices are coming to an end. In a new research note from the IMF, the global financial agency ranked mortgage default risks for households. Canada’s combination of high household debt, frothy home prices, and floating rate loans makes it the riskiest advanced economy in the world.
Canadian Mortgages Have The Highest Risk For Mortgage Defaults
Canadian mortgages have the highest risk of default in the world, according to the IMF. A combination of high household debt and frothy home prices have increased risk in the market. Households embracing floating, or fixed rate, loans turned it from just overpriced housing into over priced housing with a high risk of default.
The combination of factors amplifies mortgage default risk. “…countries with high levels of household debt and a large share of borrowing issued at floating rates are more exposed to higher mortgage payments resulting in a higher risk of defaults,” wrote Nina Biljanovska, an economist with the IMF.
Housing Market Risk Indicators
Economies with high household debt and more floating-rate loans have greater exposure to higher mortgage payments, and a heightened risk of defaults.
Countries with similar devotion to residential real estate investment and floating loans aren’t far behind. Following Canada for risk are Australia, Luxembourg, Norway, Sweden, and the Netherlands.
In case you didn’t catch it, none of those countries have economies close to the size of Canada.
Higher Rates Have Been A Buzzkill For The Global Housing Frenzy
What the heck happened? Global real estate prices surged in 2020, with the IMF attributing it to low rates and tight supplies. Low rates expand credit service capacity and incentivize borrowing, leading to the explosion of investors and overleveraged home buyers. It’s not a fringe theory, but one the BIS, the central bank of central banks, also agrees with.
As interest rates began normalization and stimulus was removed, home prices pulled back. Just lowering the incentive to borrow, and throttling leverage, was enough to pull back home prices.
Defaults aren’t likely in tight markets where home prices are rising, since a home can sell before defaulting. Adding falling home prices into the mix raises the risk of default, since it becomes more difficult to exit in a timely manner, and maintain a profit.
“On the upside, in countries where housing prices grew rapidly, price declines in the runup to the current monetary policy tightening cycle could improve affordability,” said Biljanovska.
The IMF is basing the risk on Canada’s banks following global standards. Banks have been extending mortgage repayment terms decades longer than the maximum allowed, preventing delinquencies, and reinforcing high home prices. The only thing it cost Canada is the reputation of having prudent bank regulation, and increased moral hazard which experts warn can spark a financial crisis.