New report ranks Canada as most at risk for mortgage defaults

In a new report from the United Nation’s International Monetary Fund (IMF), Canada currently faces the highest risk of mortgage default due to a combination of factors, namely high household debt and inflated home prices.

IMF conducted an analysis of mortgage default risk in 38 “mostly advanced” economies, using data provided by the Organization for Economic Co-Operation and Development (OECD), which considered five criteria to assess the level of risk: households’ outstanding debt as a percentage of gross disposable income; share of debt outstanding at a variable interest rate (fixed rate up to one year); share of households owning home with a mortgage; cumulative real house price growth; and cumulative policy rate changes.

Canada was ranked as having the highest risk level on the latter three categories, with a medium risk level on outstanding debt as a percentage of disposable income and a medium-low risk on share of debt outstanding at a variable interest rate.

Sources: BIS; ECB; Hypostat; OECD; and IMF staff calculations. Note: Criteria 1 = households’ outstanding debt as a percentage of gross disposable income, 2022:Q2; Criteria 2 = share of debt outstanding at variable interest rate (fixed rate up to one year), 2022:03; Criteria 3 = share of households owning home with a mortgage, 2020; Criteria 4 = cumulative real house price growth, 2020:01-22:01; Criteria 5 = cumulative policy rate changes, 2022:Q1-22:03. For each criteria, coun- tries obtain a score between 0 and 4 reflecting their position in the cross-country distribution. The total score is the sum of the individual criteria scores.

“Economies with high household debt and more floating-rate loans have greater exposure to higher mortgage payments, with heightened risk of defaults,” stated Nina Biljanovska, an economist with the IMF.

After Canada, the countries with the next highest risk levels are Australia, Luxembourg, Norway, Sweden and the Netherlands, according to the analysis.

In housing markets where home prices are on the rise, the likelihood of mortgage defaults is relatively low because homeowners can typically sell their home before defaulting. However, when falling home prices are introduced into the equation, the risk of default increases. This is due to the added challenge of exiting the property in a timely manner and preserving a profit, which becomes more difficult when the market is experiencing a decline in prices.

“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,” Biljanovska said.

While it is unlikely that falling home prices with cause a financial crisis like the one that occurred 15 years ago, Biljanovska said a sharp drop in house prices could dim the economic outlook.

“The build-up of vulnerabilities warrants close monitoring in coming years,” she said. “And possibly even intervention by policymakers.”