OTTAWA - Credit rating agency DBRS said Thursday that average Canadian households can withstand a catastrophic drop in home prices, but warned that a rise in unemployment would be a greater concern.
The agency said a 40 per cent drop in prices or rising interest rates would put pressure on Canadian households, but not have a large impact on mortgage defaults.
"However, a combination of higher interest rates, lower property values and a drastic increase in unemployment would be of great concern as mortgage defaults are closely related to employment and individual family situations," DBRS said in a report.
"If unemployment spikes, many financially stretched households will be forced to sell their homes, putting greater downward pressure on house prices and turning many people into both house poor and cash poor."
The report comes amid continuing warnings from Bank of Canada governor Mark Carney and federal Finance Minister Jim Flaherty that higher interest rates are just a matter of time and Canadians need to ensure they don't get in over their heads with loans and mortgages.
DBRS said that faster debt accumulation relative to the economy as a whole or average household income have driven up both home prices and borrowing.
The result has been reduced housing affordability, with pressure on day-to-day cash flow for average Canadian households, leaving them little room to deal with unexpected expenses.
"Canadian households are solvent, possessing ample home equity and other financial assets," DBRS said.
"However, day-to-day cash flow appears to be stretched, making households vulnerable to cash flow shock and credit problems from the occurrence of any of the three 'Ds' — disability, divorce and dismissal."
Household debt in Canada reached record levels of more than 150 per cent of disposable income last year, close to the 160 per cent mark that preceded the housing collapse in the United States.
Carney has warned that record high household debt is the number one domestic risk to the economy, while Flaherty has tightened mortgage lending rules three times in recent years, including reducing the maximum amortization period and hiking the minimum down payment.
Canada Mortgage and Housing Corp. and the Office of the Superintendent of Financial Institutions have also tweaked the system and may be preparing to do more.