Canadian real estate prices made huge gains, and they may all be due to cheap financing. Bank of Canada (BoC) data shows mortgage interest rates fell sharply over the past year. This boosted homebuyer budgets significantly, without increasing the size of payments. Coincidentally, the amount those budgets rose is in line with how much home prices increased.
BoC Estimates Mortgage Rates Fell 35%
The Bank of Canada estimates the typical variable rate made a sharp decline. The estimated typical variable mortgage rate fell to 1.87% on Oct 22, 2020, down 2.6% from a month before. Compared to last year, this marks a 35.5% decline. To contrast, interest rates fell about 85.7% over the past year. Mortgage rates didn’t fall nearly as much, but that was still a huge boost to budgets.
Canadian Mortgage Budgets Inflated 10-14% Over The Past Year
How did this impact budgets? Let’s do some napkin math to visualize this. Assume a buyer making $100,000 in gross income, with a mortgage over a 25-year amortization. For the sake of simplicity, we’re excluding the stress test, since it doesn’t apply at all to lenders. If the buyer sees a reduction of rate from 2.9% to 1.87%, this increases their budget by ~12.0%. According to CREA, home prices increased about 10.3% at the national level. The payments are the same as last year, but prices increased in line with the credit injection. In bankster, this means affordability was maintained, despite rising prices. Seriously.
What Happens Next?
Typically during periods of increased risk, financing costs should rise. This is how the market deals with risk – by tightening standards, until the issue is clear. The BoC decided to engage in quantitative ease though, an unconventional policy tool. Instead of rates rising with risk, they fell. Falling rates allowed price increases to be more easily absorbed, by letting households borrow more future income. Essentially, a price boost was created without any improvement to fundamentals. Actually, it came with deteriorating fundamentals, technically speaking.
Over the next few weeks, easy growth through stimulative credit expansion should ease. The BoC has halted buying mortgage bonds as of yesterday. This is likely to help financing costs return to market levels, and shrink budgets a little. With a return to market-based rates, buyers are going to need a lot more exuberance to maintain this kind of price growth going forward.
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