CMHC stress test says house prices could drop 30% on interest rate spike

A sudden interest rate increase that spikes borrowing costs, causes a big drop in house prices and leads to the failure of a domestic financial institution could cost Canada Mortgage and Housing Corp. more than $1.1 billion in insurance losses, but the federal agency says it could weather the storm.

That scenario was just one of six CMHC laid out as it revealed the results of a "stress testing" exercise it performed covering 2017 to 2021. The scenarios also include a U.S.-style housing correction, a drop in oil prices, a large earthquake and a severe economic depression.

"Stress testing involves searching out extreme scenarios that have a very remote chance of happening and planning for them," said Romy Bowers, CMHC's chief risk officer, in a statement.

"Rigorous stress testing is an essential part of our risk management program and allows CMHC to evaluate its capital levels against these scenarios."

CMHC said its capital holdings are sufficient for the scenarios it used in its test cases. The agency also cautioned that the scenarios tested shouldn't be considered a prediction or a forecast.

Depression: 25% drop

In the scenario of a jump in interest rates, CMHC said an increase of 2.4 percentage points over two years could lead to a 30 per cent drop in house prices and a peak unemployment rate of 11.3 per cent.

In the case of a severe and prolonged global depression, CMHC said its test suggested housing prices could drop by 25 per cent while unemployment could peak at 13.5 per cent. The agency could face an insurance loss of $3.1 billion.

In the event of that the price of oil falls to $20 US per barrel next year and remains between $20 and $30 US for another four year, CMHC said it could face an insurance loss of more than $3.5 billion, while house prices could slide by almost eight per cent. Unemployment could reach 8.8 per cent.

Interest rate hikes are becoming a reality for some homeowners as both Royal Bank and TD boosted their fixed mortgages rates this week, leading to some concerns about Canadians' ability to cope.

• TD Bank increases fixed mortgage rates

"Households are so leveraged right now and house prices are at such incredibly high levels relative to household incomes," said David Madani, senior Canada economist at Capital Economics.

"Even a moderate doubling in interest rates — which sounds like a lot, but we're talking about maybe 200 basis points [two percentage points] — could potentially pop the housing bubble," he said.