IN FOCUS6-8 min read

Cooling Canadian housing market poses little threat to financial stability

After a two-decade boom, Canada’s housing market is now slowing as interest rates rise. We examine the impact on the broader economy.



Irene Lauro
Environmental Economist

The Canadian housing market has seen a spectacular boom in the past two decades, with house prices among the fastest growing in the OECD.

But amid the tightening monetary policy cycle initiated by the Bank of Canada (BoC) in the summer of 2017, the housing market has started to cool down, with house prices declining on the back of softening credit growth. Interest rates have risen 125 basis points since July 2017, and household consumption has started to soften.

There are now concerns that high levels of household debt could amplify the effects of this slowdown on the economy. However, we believe that unless there is a sudden and sharp deterioration of the labour market, the financial and macroeconomic stability of the economy is set to continue.

Amid higher interest rates and tighter mortgage rules, housing market activity started to cool in the second half of 2017, with house prices falling particularly in the two priciest markets, Toronto and Vancouver. As Canadian consumers are highly indebted, concerns that declining activity and tighter monetary policy could hit household spending and threaten macroeconomic stability are looming.

The amount of debt held by Canadian households has been growing for decades because depressed interest rates since the latest financial crisis have pushed consumers to take on more debt. More recently, thanks to tighter monetary policy and the introduction of tighter mortgage rules, the BoC has successfully discouraged consumers from relying on more borrowing to finance their spending: mortgage credit has decelerated in the past two years (Chart 1).

Chart 1: Credit mortgage growth is decelerating amid high rates


Source: StatCan, Schroders Economics Group, 9 April 2019

However, as a result of higher interest payments, the debt service ratio, which measures the amount of income used for interest payments and amortisations, has risen to a 10-year high (Chart 2), with the potential to amplify the impact of a slowdown in the housing sector on the economy, which could pose a severe risk to financial stability.

Chart 2: Debt service ratio increased to its highest level in 11 years 


Source: BIS, StatCan, Schroders Economics Group, 9 April 2019

Housing prices falling from elevated levels

House prices, particularly in Toronto and Vancouver, have witnessed a spectacular run lasting several years, thanks to loose monetary policy, a growing population, high net migration inflows and increasing foreign investor participation. With the strong upward momentum in prices, some house price overvaluation has emerged and a rapid return to fair value in housing markets could potentially have a significant macroeconomic impact.

Since the BoC started its monetary policy normalisation process in the second half of 2017, house prices for Toronto and Vancouver have started to fall from their elevated levels, as a result of the adjustment of housing demand to tighter mortgage credit rules and higher rates (Chart 3).

Chart 3: House price growth is slowing down


Source: DataStream, Schroders Economics Group, 9 April 2019

As shown in chart 4, residential investment declined significantly in 2018 and housing starts and building approvals have started to decelerate, signalling that the housing market is cooling down. However, growth in housing starts and building approvals has not deteriorated to the levels of the previous housing market crisis in the early 1990s.

Chart 4: Residential investment took a hit in 2018


Source: StatCan, Schroders Economics Group, 9 April 2019

Chart 5: Housing starts and building permits not at alarming levels


Source: StatCan, Schroders Economics Group, 9 April 2019

Moreover, it is important to highlight that the slowdown in housing activity is simply due to the fact that consumers are adapting to policy changes and is not driven by supply disruptions or borrowers defaulting on their mortgages.

In the event of a sharper fall in house prices, where borrowers could find themselves with a debt load greater than the value of their house, amplification risks will be limited: data from Equifax Canada shows that home equity lines of credit account for 11% of total outstanding credit. From a financial stability perspective, one of the most important factors is that credit quality is good and that the resilience of household debt is not deteriorating.

Mortgage quality has improved

The main risk to the Canadian economy is a sharp correction in the housing market, triggered by higher interest rates or a shock to the unemployment rate that could push borrowers to refrain from making payments and starting to default while cutting their consumption. As poorer households are more likely to face tighter liquidity constraints and are therefore more vulnerable to higher rates, any drop in consumer expenditure would be amplified if a large amount of debt is held by low income households.

Analysing the amount of mortgage debt by wealth distribution shows that the top two quintiles - the richest 40% of households - hold more than 50% of Canada’s mortgage debt. Households at the bottom of the wealth distribution - the lowest quintile - hold only 12% of total mortgage debt (see chart 6).

Chart 6: Share of mortgage debt by quintile of wealth distribution


Source: StatCan, Schroders Economics Group, 9 April 2019

More importantly, the average credit score for borrowers in Toronto and Vancouver is excellent (750+) and has improved in the last decade as shown by Equifax data in Chart 7. The higher the score, the smaller the likelihood that the loan will become delinquent.

This suggests that there does not seem to be a systemic credit quality issue, and that higher rates are not likely to trigger delinquencies on mortgage payments to an extent that could undermine the country’s financial stability.

Chart 7: Average credit score has risen in Toronto and Vancouver


Source: Equifax and CMHC calculations, 9 April 2019

The labour market remains robust

While the resilience of household debt does not seem to be a pressing concern, a potential risk of a broader slowdown in both housing and economic activity could stem from a severe deterioration of the labour market where the unemployment rate sharply increases and borrowers are not able to repay their debt.

However, the labour market strengthened significantly last year, with the economy adding a net 194,000 full-time jobs in 2018. The labour market has continued to improve in the first three months of this year, as 90,000 full-time jobs were added. Moreover, the participation rate is near its all-time high, while the unemployment rate remains below its natural level and close to a 40-year low.

This positive trend in employment is set to continue in the next twelve months, as suggested by the business outlook survey, where hiring intentions are still pretty robust and continue to rise.

As a sudden reversal and deterioration in Canadian labour market trends seems unlikely, robust employment growth is expected to continue to support household income, offsetting some of the income losses from tighter financial conditions.


Household debt has grown to elevated levels in the last two decades, raising concerns over the country’s vulnerability to higher interest rates. The housing market has started to show signs of cooling, with house prices falling from elevated levels and residential investment lower in 2018.

However, the slowdown is being driven by demand adjusting to policy changes and, as long as credit quality remains strong and the labour market does not deteriorate, macroeconomic stability is set to continue.


Irene Lauro
Environmental Economist


Follow us

Schroder International Selection Fund is referred to as Schroder ISF throughout this website.

For illustrative purposes only and does not constitute a recommendation to invest in the above-mentioned security / sector / country.

© Copyright 2020 Schroder Investment Management (Europe) S.A., German Branch is subject to the Luxembourg law dated 17 December 2010.