Canadian Real Estate Prices Increased So Fast They Eliminated The Benefit of Low Rates

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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  • Jason Chau 3 years ago

    Lowering rates should be 100% about increasing demand, not improving affordability. The market has more access to capital than people do. It’s a small benefit to some people, and a huge benefit to those with more capital than they know what do with.

  • Travis Hunter 3 years ago

    Sloppy, sloppy Canada. Meanwhile New Zealand’s killed their MBS program, QE, and hiked the policy rate to stop home prices from rising.

    • Derek 3 years ago

      Macklem did one better at the last meeting. He told everyone the stimulus would continue into the foreseeable future. Even as rates increased not on the prospect of the economy growing, but due to inflation concerns becoming crushing.

  • Hannah Goodman 3 years ago

    Oh, Canada. My home and bubbley land.
    True mortgage love in all of us command,

    • MD 3 years ago

      Canadian house prices are inflated in Vancouver especially by foreing investors most of whom are hiding money from. their own countries government taxes and illegal buying procedures. See Global news article “Secret CRA study has shocking information on Metro Vancouver real estate market” How does a working family needing to qualify to borrow for a home compete with people paying cash and declaring 0 to negative income? Like some other countries we should not allow foreign ownership of housing.

  • Dorian 3 years ago

    Not buying a home a 4-5 back is one of my biggest regrets. I had the cash for a downpayment, but then decided to stay on the sidelines as I didn’t want a large mortgage to limit my ability to take chances – and given how fast the market was moving, it looked irrationally exuberant to me back it. I have been fortunate that my income has doubled in the past 4 years, but the amount I make after taxes is puny compared to what a real estate invested would’ve yielded. Despite being high income, I’m forever shut out from owning a decent home in Toronto.
    If I didn’t analyze the decision quite as rigorously (which included perusing BD), then I would’ve been much much better off. As it turns out, not only is ignorance bliss, it’s also be very very profitable.

    • Olivia 3 years ago

      Not mine. It’s a joke to see people blame BD (when they started in 2016 they weren’t negative about the market at all, they were just pointing out the money laundering in Vancouver). If you felt that was a reason not to buy, then that’s on you.

      If you missed that opportunity, Toronto’s detached market dropped 30% in 2018 as did Vancouver. It was back to 2015 levels, but the same people blaming everyone else didn’t buy then either — they missed the opportunity again. Meanwhile, they didn’t try investing in any other areas, they just waited and said too much risk to do anything.

    • buy low 3 years ago

      There are even better investments compere to real estate. Give you more financial freedom. Tesla, Facebook, Costco and Amazone shares and even more profitable. During pandemic crash on average in one year up to 65% gain.
      Long term investments are the best.

  • Zesnen Yuskavich 3 years ago

    This is a big win for canada. Canada is back!!

  • Joanne O 3 years ago

    As a retired realtor, I remember when interest rates accelerated to 21%. The result was catastrophic! For all those mortgagors, CAUTION. When a mortgage is renewed, you may have lost control.

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