In its effort to cool inflation, the Bank of Canada moved quickly to raise interest rates – eliminating housing demand. But while this move will deter many potential homebuyers from the property market, there are others who won’t be upset.
The central bank has already raised interest rates twice this year, and is expected to raise rates again on Wednesday.
The move has had a cooling effect on the GTA housing market, but experts say that while homebuyers already in the market, those with equity holdings, and REITs largely insulated from price increases, they are the lowest in the real estate ladder hardest hit.
This means first-time homebuyers, new immigrants, and those with fewer savings to enter the market, said Robert Hogg, chief economist at RBC.
“They will be most affected because they need to borrow more from the lender and are more sensitive to higher interest rates,” he said.
During the pandemic, the Bank of Canada’s overnight interest rate fell to a historic low of 0.25 percent for two years. In the economic recovery, inflation rose to 6.8 percent in April 2022. To cool inflation, the central bank raised the overnight interest rate, which settled at 1 percent after a 0.5 percent increase last month – the largest central bank rate increase since 2000. This rise came after the Bank announced a 0.25 percent increase in March.
On June 1, the central bank is expected to raise another 0.5 percent, repeating the same increase in July, bringing the overnight interest rate to 2.5 percent by the fall.
Interest rates on fixed rate mortgages are around 4 per cent, with rates for many major banks hovering around 4.5 per cent – already up about one per cent in less than two months.
Variable-rate mortgages in the 2 to 2.5 percent range are now offered by major banks, a significant increase from the historically low 1 percent offered in the pandemic. Since variable rates are linked to the central bank’s overnight rate, interest rates are expected to rise significantly.
Back in January 2020, when the average five-year fixed interest rate was 2.5 percent, it was a homeowner who bought a $1 million home, had $200,000 in income, and made a 20 percent down payment with a 25-year amortization . A monthly mortgage payment of $3,584. At 1.4 percent – the lowest rate during the pandemic – the monthly payments would be $3,161. Currently at 4.2 percent, the monthly payments would be $4,295 for this home.
If the same person bought the same home at a five-year variable rate of 2.6 percent in January 2020, their monthly premium would be $3,624. At 1.15 percent – the lowest average variable rate in the pandemic – the payments would be $3,069. Now, at 2.2 percent, they will receive a monthly payment of $3,465.
Real estate experts say interest rates are back to pre-pandemic levels and are unconcerned about increases, but housing advocates say with property prices soaring throughout the year, higher interest rates are making the market more difficult.
In GTA, prices increased by 15 percent from April 2021 to April 2022, even as prices have fallen in the past few months.
Eric Lombardi, a housing advocate and founder of More Neighbors Toronto, said, pointing to the younger generations and new immigrants, they will be excluded from the market.
It’s important to remember that the buyers’ market is not homogeneous, said Murtaza Haider, professor of data science and property management at Toronto Metropolitan University.
“There is a segment of society that is not afraid of interest rate movements and has enough wealth and income to adjust, but there are many people who are exposed to the slightest change that hurts their chances of what they can qualify for,” he said.
He added that for those with lower incomes, this is not the best time to buy a property. If home prices fall further, when it’s closing time, valuations could return tens or hundreds of thousands of dollars, leaving people scrambling to pay the difference or risk losing their deposits.
“If this happens to someone who does not earn a higher salary, they will be in a very difficult position to make up for the shortfall,” Haider said.
Another demographic at risk of price hikes is people with a Home Contribution Line of Credit, or HELOC – a line of credit guaranteed by a person’s home that provides a revolving line of credit for use on large expenses.
Many homeowners have used HELOCs to make investments in another property – allowing the homeowner to obtain a second mortgage. But more often a variable mortgage is used, not a fixed one.
“With prices starting to fall, will you find that multiple buyers with excess leverage are unable to afford these increased payments? Will they bring more supply to the market? I think it is an underestimated possibility,” Lombardi said.
However, homeowners looking to increase or decrease the size will be able to do so if they have a Good capital gains on their holdings and more equity, Hogg said, because they are less dependent on borrowing for mortgages and therefore less sensitive to higher rates.
Part of the real estate industry that will remain strong even as prices rise are real estate investment trusts, or REITs, said Robert Cavic, chief economist and chief economics officer at BMO.
Real estate investment trusts are companies that manage a real estate portfolio and can be publicly traded. Kavcic said the portfolio of stocks they manage is usually well diversified across many properties, the most popular of which are multi-family apartment buildings (due to the influx of immigrants settling in these properties) and the industrial side of commercial properties.
“I can’t see interest rates hurting the strength of these investments,” he said. “Prices may be affected, but the interest in these properties will stay with us.”
Kavcic said higher rates have a positive side. It helps to remove speculative activity and regulate the interest of investors to normal levels. He added that during the epidemic sales activity increased by 30 to 50 percent than normal. Now, there are more listings on the market with fewer bidding wars.
However, the root cause of the housing affordability crisis is not interest rates. Supply is limited and demand is huge, Kavcic said.
RBC’s Hogg added that since there is ample supply, affordability depends on housing prices and income.
While home prices are slightly down from their February peak, with some markets seeing a much bigger drop as in GTA taxes, Toronto prices are still strong. Meanwhile, Statistics Canada warns that wage increases this year are likely to be modest.
“Affordability is going to get worse before it gets better,” Hogg said. “People will have to move to other markets where house prices are lower, perhaps buy an apartment instead of a semi-detached apartment, or continue to rent…Concessions will have to be made.”
Join the conversation