Indicators of financial vulnerabilities

Learn about the indicators we use to track the evolution of two vulnerabilities in the Canadian economy: the elevated level of household indebtedness and high house prices.

The Bank of Canada promotes the country’s economic and financial welfare by fostering a stable and efficient financial system. As part of this commitment, the Bank identifies and monitors areas of vulnerability in the economy and financial system. Vulnerabilities are pre-existing conditions that may interact with changes in the economy and lead to episodes of financial stress or even a financial crisis. They can amplify and further spread shocks throughout the financial system. The interaction between vulnerabilities and shocks can bring about risks that could impair the financial system and harm the economy.

In recent years, the Bank has assembled a comprehensive set of indicators to track the evolution of two particular vulnerabilities—the elevated level of household indebtedness and high house prices. This page presents these indicators.

The indicators will be updated on a quarterly basis at or near the beginning of each of the following months:

  • March (showing data from the fourth quarter of the previous year)
  • June (showing first-quarter data)
  • September (showing second-quarter data)
  • December (showing third-quarter data)

Publication dates may vary depending on data availability. Data are subject to revisions.

For metadata and background information on these indicators, see the notes.

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Indicators related to the elevated level of household indebtedness

This vulnerability relates to households’ ability to continue servicing their debt if their income declines or interest rates rise, without having to significantly reduce their consumption. Typically, if disposable income declines, households that allocate a large share of their income to debt payments would need to cut back on consumption spending by more than they would if that share was smaller.

Characteristics of mortgage originations

When a homebuyer obtains a new mortgage to purchase a house, the characteristics of the transaction can vary:

  • Mortgage insurance status—Some mortgages must be insured, while others do not have to be. Homebuyers who have a down payment of less than 20% must obtain insurance on their mortgage.
  • Type of interest rate and length of term—A mortgage can have either a variable or a fixed interest rate, and the number of years before the mortgage must be renewed with the lender—known as the term—can vary.
  • Amortization period—This is the length of time it takes to pay off a mortgage in full. Homebuyers who have an insured mortgage are limited to a maximum amortization period of 25 years.
  • Mortgage interest rate—The specific rate of interest charged depends on whether a mortgage has a fixed or variable interest rate.

Loan-to-income ratio

The loan-to-income (LTI) ratio is a measure of initial affordability. It is calculated when a new mortgage is issued and compares the size of the mortgage to the gross income stated by the homebuyer when they qualified for the mortgage. Research by Bank staff found that, all else being equal, homebuyers with higher LTI ratios are more vulnerable to financial stress (Bilyk, Chow and Xu 2021). This means that highly indebted homebuyers are more likely to fall behind on debt payments if they experience a negative income shock or a rise in mortgage interest rates. The Bank uses the share of new mortgages with an LTI ratio greater than 450% to identify the most vulnerable households.

Loan-to-value ratio

The loan-to-value (LTV) ratio is a measure of the initial equity stake that a homebuyer has in their house. It is calculated when a new mortgage is issued and compares the size of the mortgage to the market value of the property. The smaller the down payment made by the homebuyer relative to the purchase price, the higher the LTV ratio. Homebuyers can borrow up to 95% of the value of their home (excluding the mortgage insurance premium, which is added to the value of the loan after approval). However, borrowers with an LTV ratio greater than 80% must obtain insurance on their mortgage and are not eligible for mortgage refinancing. Research by Bank staff found that, all else being equal, homebuyers with higher LTV ratios are more vulnerable to financial stress (Bilyk, Chow and Xu 2021). In other words, they are more likely to fall behind on debt payments in the event of a negative income shock or a rise in mortgage interest rates.

Mortgage debt service ratio

The mortgage debt service ratio (DSR) measures the share of income a homebuyer dedicates to their mortgage debt payments. All else being equal, a household that spends a large portion of its income on mortgage payments may be more vulnerable to financial stress—it may be more likely to fall behind on debt payments if a negative income shock or a rise in mortgage interest rates were to occur. The Bank uses the share of new mortgages with a mortgage DSR greater than 25% to identify the most vulnerable households.

Household credit performance

Tracking households that are having difficulty making debt payments provides a good indicator of household financial strain.

A common measure of borrowers’ financial stress is the share of indebted households that are behind on payments for at least 60 days in any credit category. Credit categories include mortgages, credit cards, loans (automobile and other) and lines of credit (secured and unsecured). Because mortgages are typically the last product to go into arrears, missed payments on other types of debt can be early signs of financial distress.

Households with loans in arrears are defined as those that are late on their debt payment obligations by 90 days or more. The rate of loans in arrears can be observed on any type of debt and represents the share of households that are behind on payments on a given type of debt by three months or more.

Indicators related to high house prices

House prices have climbed considerably since the start of the global pandemic. Expectations of future price increases and strengthened investor demand likely contributed to this rise. A large misalignment of house prices relative to longer-term market drivers could lead to an abrupt price correction in the future. Such a correction can, in turn, bring on financial stress for households because housing often represents their largest asset.

Resale market activity and prices

The Canadian Real Estate Association compiles monthly statistics on the resale market in Canada through its Multiple Listing Service (MLS®). These statistics serve as valuable indicators to assess the vigour of the housing market. In particular, the Bank pays close attention to the number of existing residential properties sold in a given month and how the prices for those properties have evolved.

A useful indicator of the balance of supply and demand in the resale market is the ratio of sales to new listings. When the ratio hovers between 40% and 60%, this suggests a balanced market. When sales outpace the new supply of existing houses for sale, the ratio becomes higher and the market is then characterized as a seller’s market. Alternatively, when sales are weak relative to new listings, the ratio is low and the market is more favourable for buyers.

The demand for and supply of resale properties influence resale prices. The Bank regularly tracks many indicators of house prices and monitors the evolution of the MLS® Home Price Index (HPI) in particular. The HPI benchmark price controls for changes in the composition and quality of houses sold in a given month.

Types of mortgaged homebuyers

The Bank also looks at the share of mortgage-financed home purchases associated with three types of buyers (as defined in Khan and Xu 2022):

  • First-time homebuyers are new homebuyers who have never had a mortgage on their credit file.
  • Repeat homebuyers are those who obtain a new mortgage and discharge a previous mortgage.
  • Investors are homebuyers who obtain a mortgage to purchase a property while maintaining a mortgage on another property.

As explained in Box 2 of the Bank’s 2022 Financial System Review, the presence of investors in real estate markets can amplify house price cycles. During housing booms, greater demand from investors can add to bidding pressures and intensify price increases. Similarly, when prices are stable or declining, a lower influx of investors can add downward pressure on housing demand and prices.

House-flipping activity

House flippers are individuals who buy homes and resell them a short time later. Although a rise in house-flipping activity may improve the quality of the housing stock if renovations are involved, it may also signal that a local market is becoming increasingly influenced by speculative behaviour.

The definition used for this indicator is the share of homes resold within either 6 or 12 months of purchase. The data are expressed as a share of the total number of transactions in a geographical area in a given quarter. Data are reported as a 12-month moving average.

House price expectations

Expectations of growth in house prices collected through the Bank’s Canadian Survey of Consumer Expectations are a useful indicator of the tightness of housing markets. Survey participants are asked what they expect the percentage increase in average home prices in their area to be over the next 12 months. Note, however, that median expectations of growth in house prices from this survey tend to differ significantly from the growth rates of published indexes of house prices. Therefore, focusing on changes in expectations over time rather than on absolute levels is more informative.

References

Bilyk, O., K. Chow and Y. Xu. 2021. “Can the characteristics of new mortgages predict borrowers’ financial stress? Insights from the 2014 oil price decline.” Bank of Canada Staff Analytical Note No. 2021-22.

Khan, M. and Y. Xu. 2022. “Housing demand in Canada: A novel approach to classifying mortgaged homebuyers.” Bank of Canada Staff Analytical Note No. 2022-1.