With interest rates continuing to rise, the Bank of Canada is sounding the alarm about rising home prices and the increasing number of households with high mortgage debt.

The bank said in its annual financial system report: "In Canada, high levels of household debt and rising home prices remain two key interconnected vulnerabilities."

Although home prices increased by 53% nationwide between April 2020 and April 2022, the bank is concerned that new homebuyers lack equity and face increased financial pressure when renewing mortgages at higher rates.

Last week, the Bank of Canada indicated that it is ready to raise its key interest rates above the previous target of 3%, which would put those with variable-rate mortgages and home equity lines of credit under additional pressure.

The bank says many new homebuyers "made a financial effort" to purchase a property at record prices due to the "fear of missing out" on the ongoing rise in home prices across the Canadian housing market. The bank blamed the huge rise in home prices on strong demand relative to supply and the increasing number of investors snapping up properties.

These investors take equity from other properties they own to make new purchases, which the bank says "highlights the feedback loop between rapid gains in home prices and strong demand for housing generated by investors."

Home prices remain at all-time highs across Canada, but the bank warns that it is too early to tell whether the recent decline in resale activity and prices is "temporary or the beginning of a deeper, lasting decline."