Canadians were given a boost to affordability when rates were cut at the start of the pandemic. The Bank of Canada‘s housing affordability index fell to the most affordable level in over a decade. By cutting interest costs, households can finance debt more cheaply, improving affordability. It also happens to increase demand though, pushing home prices higher. If left for too low, for too long — the benefits of low rates are outweighed by higher prices. Canadian real estate is now way past that point.
Housing Affordability Index
The Housing Affordability Index (HAI) is the BoC’s official affordability measure. It looks at the share of disposable income required to service the cost of housing. As the index rises, people need to spend more of their income to service a mortgage. This means affordability is on the decline. When the index falls, it means people are spending less on their housing costs. This means affordability is improving. Really complicated stuff, I know.
Canadian Housing Affordability Is The Worst It’s Been In Over A Decade
Households need to spend the largest share of income to carry a mortgage in well over a decade. The share reached 36.3 percent of income in Q2 2021, up from 34.7 percent in the previous quarter. In other words, over a third of income is now needed to service a typical mortgage across the country. Not just in Toronto or Vancouver, but at the national level.
Canadian Housing Affordability Index
The percent of disposable income needed to carry the mortgage payments on a typical home across Canada.
Source: Bank of Canada; Better Dwelling.
When the pandemic first started, rates were slashed greatly improving affordability. The index fell to 30% — over 6 points lower than it stands today. Things are deteriorating so fast, the index jumped by nearly 2 points in just the most recent quarter. Canada went from having the most affordable real estate in over a decade, to the least, in the span of 12 months.
How High? High Enough To Touch The Sky
The index has now reached the highest level in over a decade, clearing all but a few quarters in the past two. Only three quarters over this period have been higher — from Q3 2007 to Q1 2008. Back then the overnight right was 17x higher, meaning a lot more interest was being paid.
Low Rates Make Debt More Affordable, But Increase Demand
The biggest benefit of low interest rates is a lower cost to carry debt. In a perfect world, you pay the same purchase price for a house, but less in interest. When you do it in a bubble, people think of the money saved as extra money to bid up prices. It’s a lot easier to push prices higher when the bank tells people they can “afford” to spend more. It’s also a lot easier for mom and dad to borrow their home equity and provide help with a downpayment. After all, it’s so cheap — how could you not borrow?
The Benefit of Cheap Debt Has Been Lost To Increased Demand
Unfortunately, cutting interest rates also means stimulating demand. They’re often used during periods of low consumption, to pull consumers forward. Pulling a cohort of buyers forward and expanding credit for the current cohort predictably leads to higher home prices. This is especially true when existing-home sales are near record levels, and you pour gas on that fire.
Canadian real estate sales were strong before the pandemic, with solid price growth. When the pandemic started, slashing rates provided a huge boost to affordability. It also created so much excess demand, rising prices consumed any benefit. Slashing rates further might seem like a solution to the “duct tape repair” crowd, but would ultimately make things worse. Especially in an environment where inflation is already spiraling out of control.
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