‘Sudden’ spike in interest rates could trigger housing crash, unemployment spike: CMHC

CMHC's stress tests suggest what could happen to Canada's housing market if the worst were to occur.
CMHC's stress tests suggest what could happen to Canada's housing market if the worst were to occur. AP Photo/John Bazemore, File

A “sudden increase” in interest rates could send house prices crashing and unemployment rates soaring, data released Thursday by the Canada Mortgage and Housing Corporation (CMHC) suggests.

The Crown corporation tested a collection of extreme hypothetical scenarios including a “US style housing crash,” an interest rate hike and even a devastating earthquake as part of an annual stress test.

READ MORE: CMHC issues ‘red’ warning for Canada’s housing market

The CMHC’S stress test indicated that a “sudden increase” in interest rates, resulting in higher borrowing costs for Canadians, could cause housing prices to fall 30 per cent, while pushing unemployment as high as 11.3 percent.

First they upped interest rates by 1 per cent, then an additional 1.4 per cent.

Higher interest rates tend to reduce spending and investment, which can result in higher unemployment.

Story continues below advertisement
WATCH: Homebuyers and owners brace for rising mortgage rates 
Click to play video: 'Homebuyers and owners brace for rising mortgage rates' Homebuyers and owners brace for rising mortgage rates
Homebuyers and owners brace for rising mortgage rates – Nov 16, 2016

On top of the impact on Canadians, the corporation, which provides insurance to Canadians who are looking to get a mortgage with less than 20 per cent in cash or equity, would take a $1.13 billion loss.

The report comes amid mortgage rate increases by both TD Bank and RBC Royal Bank.

READ MORE: Here’s how much mortgage payments will go up as banks hike rates

The CMHC, as part of its Thursday release, also suggested that a “US style housing correction” in Canada would have a similar affect as the sudden increase in interest rates; home prices could fall 30 per cent, and unemployment could hit 12 per cent. That nightmare scenario would result in a more than $2 billion loss for the corporation.

But as bad as this all sounds, the CMHC is confident they are ready to battle any storm: the results of their stress test found that its capital holdings “are sufficient for even the most extreme scenarios.”

Story continues below advertisement

Regular stress tests are required for all financial institutions in Canada, as outlined by the Office of the Superintendent of Financial Institutions Canada (OSFI). The tests explore the resiliency of the institutions to withstand the worst-case scenario.

“It’s not a prediction of how things are going to unfold,” Romy Bowers, CMHC’s chief risk officer was careful to point out.

“It’s about best practices, risk management practice, of looking at very extreme events and seeing how they will impact our balance sheet and capital position.”

READ MORE: Failed the mortgage stress test? Alternative lenders await — at a price

As of last month, all insured mortgages must pass a stress test of their own, which determines whether a borrower would still be able to pay their mortgage if interest rates were to rise.

Story continues below advertisement

The stress test for Canadians comes along with new federal mortgage rules intended to help prevent a housing crash.

CMHC’s business-as-usual projection estimates that over the next five years, unemployment will hover around 6.6 per cent, while housing prices will increase by nine per cent. This would net the CMHC nearly $6.5 billion.

Sponsored content