In order for a housing bubble to form, three conditions must be in place:
Prices are too high compared to historical averages.
Banks are too eager to give credit to those who may not be able to afford it.
Government policy allows people to get in over their heads (i.e. Zero down/40 year mortgages).
Analysts Kate Warne and Craig Fehr feel the first two ingredients are in place and in order to avoid the third, the Federal Government is taking steps to tighten mortgage availability. Although it seems Canada mirrors our neighbours to the south in all things financial (albeit with a slight delay), it is hoped we will not follow in their footsteps in regards to the bursting housing bubble.
Certain regions of the country seem to be more vulnerable to a bubble burst than others. Vancouver, BC has been engulfed in frenzy of real estate activity and is leading the pack when it comes to fulfilling the first of the three conditions noted above. In the last year the market has seen a 14% increase in home prices, propelling the average home close to the $1 million mark; that makes the beautiful West Coast city the most expensive market in North America.
Recent stats indicate that home sales for June in Vancouver have dropped over 30% compared to last year's numbers. Vancouver is not alone as Toronto saw a drop of 23% and Calgary is showing a decrease of close to 40% for the same time frame. In order to combat these figures, prices will have to come down significantly. The government has tightened lending regulations making it harder to obtain a mortgage (helping avoid condition #3); however, this move, combined with climbing interest rates, will spell disaster for those homeowners that bought high with variable rate mortgages that will soon come due. These unfortunate souls will soon find themselves with mortgages that are far greater than the value of their properties; properties they could not really afford in the first place.
Until now Canada has had a very low mortgage default rate compared to the U.S: less than 1/2% vs. close to 4%, but this could soon change for the worse if prices continue to drop and interest rates keep crawling up. The fear here lies in the viscous circle that is created, as evidenced south of the border, when foreclosure rates increase. More foreclosures on the market mean lower overall house prices, and lower prices mean more defaulted mortgages(can you hear the bubble stretching?).
Tighter regulations and higher borrowing rates will prevent future home buyers from getting in over their heads, but are the new policies going to be able to prevent a true bubble burst, or are we destined to follow in our neighbours' path. Let's keep our fingers crossed!
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