There is no offense to crowd building more homes, but the quickest path to more affordable housing is lower prices.
Correction: much lower prices. With rising mortgage rates, affordability can worsen even as rates drop.
The real estate boom of the past two years has led to a crisis in affordability for young people aspiring to own a home. With housing markets plummeting in the spring of 2022, it’s time to consider the near-term viability of homes to become affordable.
The allowance here is the mortgage rates. They are the biggest decision maker now in affordability, not prices.
Several national real estate brokers offered 4.19 percent of their five-year flat rate mortgage as of early this week, nearly double last fall’s level. We’ve seen changes in the high-speed mortgage rate before in recent decades, but it’s on the downside. Further price increases are possible.
Home prices are falling, but only recently. The national average resale price in April rose 7.4 percent to $746,146 year over year, but was down 6.2 percent from March. In Toronto, the average April price of $1,254,436 was up 15 percent year over year and down 3.5 percent from March.
To understand the interaction of price and rate changes, consider a home purchased in February with a national average price of $816,720. Mortgage rates were cheaper back then, so let’s add a five-year flat rate of 2.5 percent that gives us a $3,395 monthly payment based on a 10 percent down payment and a 25-year amortization.
Now, for comparison using today’s fixed mortgage rate of 4.19 percent for five years and the average April rate of $746,146. This combination of lower rates and higher borrowing costs gives you a monthly payment of $3,714, which means $319 more per month than in February.
Imagine mortgage rates are down for a while, but rates drop another 10 percent or so in the coming months to $671,500. With the same 4.19 percent mortgage rate on offer today, the monthly payment comes to $3,342. We’re now $53 cheaper per month from February, which is a start to improving affordability.
Upward pressures on mortgage rates have eased for now, but further increases may occur in the coming months. A rise in the 4.5 percent five-year fixed-rate mortgage would push the payments on a $671,500 home to $3,449. Goodbye, affordability gains.
Could further price drops help? The experience of the past 40 years in real estate suggests that you are not getting your hopes up.
Canadian Real Estate Association data has shown seven annual price declines on a national average basis since 1981. The range of declines has ranged from 0.5 percent to nearly 5 percent, with an average of 2.7 percent. As boomers and seniors will remember, there was a massive decline in Toronto in the 1990s with peak annual valley prices dropping 23 percent over six years.
The Toronto example seems more appropriate today, given that it resulted from an intense level of speculation in residential real estate. People who build more homes argue that we have a supply problem in housing today, but the demand from people who buy homes as an investment is a major cause of today’s unaffordability problem.
High prices hurt the investment attractiveness of owning a home to flip or rent. If investors pull back from the market, there will be less competition to buy homes, reducing upward pressure on prices. This may explain why housing is quieter now, with fewer buyers competing for homes for sale.
Reducing bid wars in and of itself is a victory for affordability in that you have the ability to predict the price to close the deal. But real progress on affordability will only come from lower monthly mortgage costs and down payments.
Down Payment Costs Drop – The amount required to pay a 10 percent down payment fell more than $7,000 from February to April based on average national resale prices. But the monthly mortgage payments are higher.
Building more homes won’t lower those payments in the near term, which means you’ll need a steeper price drop than an increase in the mortgage rate. Average prices are up more than 50 percent in the past two years, so it’s not out of the question.
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