Canada’s central bank quietly updated its real estate affordability index. It wasn’t good news. The Housing Affordability Index (HAI) made a big jump in Q3 2021. Maintained by the Bank of Canada (BOC), the HAI shows the share of income required to service a mortgage on a home. Low rates are no longer helping affordability, but fueling prices that outpace wages. As a result, affordability has now reached the worst level since the Great Recession.
The Bank of Canada Housing Affordability Index
The BoC Housing Affordability Index shows the share of income needed for housing costs. More specifically, the share of disposable income an average family would use. Housing costs are defined as mortgage payments and utilities. Excluded are other important costs like property taxes, used to qualify for a mortgage.
If the index falls, housing affordability is improving. A smaller share of income spent on shelter costs is generally a good thing. When the index rises, housing affordability is deteriorating. A greater share of income is needed to service a mortgage.
The model has been historically dependent on interest rates to improve the ratio. With the BoC’s overnight rate next to zero with soaring inflation, there’s little room to cut rates. This leaves them with just one move, which will either lower home prices or send costs soaring.
Canadians Need To Spend Over 37% of Income To Service A Mortgage
Canadian housing affordability has rapidly deteriorated over the past year. A home across Canada required 37.1% of disposable income in Q3 2021, up 5.2 points in the year. This is the highest ratio going all the way back to 2008.
Canadian Housing Affordability Index (HAI)
The percent of disposable income the average Canadian household needs to spend to carry the mortgage and utilities on a home.
Source: Bank of Canada; Better Dwelling.
The big difference is 13 years ago, home prices were 58% lower, and interest rates were almost 5 points higher. Further lowering interest rates might provide a limited relief from payments. However, a much bigger share of the population is likely to suffer from high inflation.
The BoC Just Discovered Low Rates Make Housing Less Affordable — Seriously
Traditionally it was believed that low interest rates made home prices more affordable. Logically, this makes sense if you don’t think too hard about it. Cheaper money means payments should be less. However, lowering interest rates is also the mechanism the central bank uses to stimulate demand. If fast-rising home prices see an increase in demand, it usually sends prices higher.
There’s also the issue of interest rates relative to inflation. When interest rates are below the rate of inflation, the BoC is devaluing debt. This is often inflationary, with households adjusting the amount they borrow. A recent study by BoC staff confirms this, showing the past 30 years of falling rates made housing less affordable. Maybe one day someone in leadership at the BoC will actually read it. If Gen Z is lucky, it won’t take another 30 years.
The BoC is now in unchartered territory and appears uncertain about their next move. The central bank is frozen, despite the obvious move being raising interest rates. In 2017, the BoC felt the economy was running too hot and began raising interest rates. Today, they have stronger economic indicators, and feel the economy can’t handle it.
If they raise rates and prices fail to fall, they’re just stuck with higher costs. Most likely this is why one of Canada’s oldest banks said this should have happened a year ago. Maybe next crisis.