Newspaper article The Canadian Press

Bank of Canada Raises Concerns over Home Equity Loans, Housing Correction: BoC Worries about Home Equity Loans

Newspaper article The Canadian Press

Bank of Canada Raises Concerns over Home Equity Loans, Housing Correction: BoC Worries about Home Equity Loans

Article excerpt

OTTAWA - Canadians are becoming increasingly vulnerable to a housing correction, exposing them to a perfect storm of high debt and falling assets, the Bank of Canada warns.

In a book of four research papers released Thursday, the central bank suggests many Canadians have constructed their finances on a house of cards, with ever rising home values the key and vulnerable support.

The bank economists point out that home prices have risen sharply in the past dozen or so years along with debt, as households needed both bigger mortgages to buy homes and used equity from higher home values to finance other purchases.

"These facts are interrelated, since rising house prices can facilitate the accumulation of debt," the report notes. "Households therefore experience a significant shock if house prices were to reverse."

It adds that falling home prices could have a "relatively large impact on consumption" as equity disappears and the ability of householders to borrow is diminished.

It calculates that a 10 per cent drop in home prices could generate a one per cent decline in consumption, which would slow economic growth.

TD Bank chief economist Craig Alexander said the fact the central bank devoted it's winter review on a single topic -- debt -- demonstrates how seriously it takes the issue.

And he says the bank's example of a 10 per cent correction is not unrealistic given that it is the over-valuation figure the International Monetary Fund gives for Canadian housing stock. Alexander himself believes it could be as much as 15 per cent.

He agrees that the central bank has every reason to be worried, because a correction could knock the stuffing out of Canada's fragile recovery.

"When it comes to the housing market and personal debt, I'm not worried that a housing market correction will lead to a problem in the Canadian financial system," he said.

"I worry more about the economy. I worry that if you have a drop in home prices and you wind up with consumers struggling to deleverage, it will lead to an economic contraction."

The bank does not suggest a U.S.-style housing collapse for Canada is in the offing, nor does Alexander. A big part of the problem south of the border was due to easy credit conditions, something Canadian banks have avoided.

But the bank's economists are clearly concerned nevertheless about the pitfalls from the steady increase in household debt, which has risen as a percentage of income from 110 per cent in 1999 to 153 per cent currently. …

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