Interest rate hike to ‘intensify’ Canada’s housing market downturn

Homes for sale in Ajax, Ont., on Sept 7. In the Toronto region, the home price index declined nearly 16 per cent from March to August, with some of the city’s suburbs losing more than 20 per cent.Fred Lum/The Globe and Mail

Canada’s real estate slump is about to deepen, as the rising cost of borrowing pushes more buyers out of the market, economists predict.

In announcing its latest interest-rate hike on Wednesday – to 3.25 per cent from 2.5 per cent – ​​the Bank of Canada said the overnight lending rate will need to go even higher to dampen inflation.

Since the central bank started lifting interest rates from the low of 0.25 per cent in March, home sales have plunged along with home prices.

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“We see the downturn intensifying and spreading as buyers take a wait-and-see approach while ascertaining the impact of higher lending rates,” said Robert Hogue, assistant chief economist with Royal Bank of Canada.

So far this year, home prices have recorded their sharpest five-month drop since the global financial crisis in 2009. The national home price index is down 6 per cent from its peak in February. The index is the industry’s preferred measure of home prices because it adjusts for volatility and excludes the high end of the market.

In the Toronto region, the home price index declined nearly 16 per cent from March to August, with some of the city’s suburbs losing more than 20 per cent.

Mr. Hogue said the country’s priciest real estate markets, which include the Toronto suburbs, were the most vulnerable to declines because of their unaffordability and their previous astounding price increases.

In the first two years of the pandemic, the typical home price in Durham region, east of the city, rose nearly 90 per cent, while prices climbed nearly 70 per cent in Halton, to the west. These suburbs are now leading the way down with typical Durham home prices falling 21 per cent or $249,300 over the past five months, according to the local real estate board. Prices in Halton have dropped by 23 per cent or $337,700 over the past six months.

After a slow summer in which sales fell below prepandemic levels in some parts of the country and homes lost value, realtors were hoping the market had reached bottom.

But economists say home prices will continue downward. Bank of Montreal economists said the central bank’s guidance solidified their view that the national home price index could fall by 20 per cent from the peak earlier in the year to the bottom sometime next year.

Borrowers will soon pay more in interest. It’s just a matter of when. Most holders of variable rate mortgages have static monthly payments, but they will immediately see a higher share go toward interest rather than paying down principal. People with fixed-rate mortgages will pay a higher monthly amount when they renew them. Homeowners with a home equity line of credit will immediately pay a higher interest rate on their loan.

It will also continue to be harder for would-be buyers to qualify for a mortgage, and they will be able to get less. “Borrowing power is going to be reduced once again,” said Don Scott, chief executive officer of mortgage brokerage Frank Mortgage.

Today’s interest-rate hike will make the mortgage stress test harder. Under federal bank rules, borrowers must prove they can make their monthly mortgage payments at an interest rate that is at least two percentage points higher than their actual rate.

According to Mr. Scott, the cheapest variable-rate mortgages may soon be 4.35 per cent and the lowest five-year fixed mortgage rate will top 5 per cent. That means borrowers will have to prove they can cover their payments with an interest rate at 6.35 per cent and 7 per cent, respectively.

And this in turn means would-be homebuyers will not be able to spend as much. It will be particularly hard for first-time homebuyers, said Laura Martin, chief operating officer of mortgage brokerage Matrix Mortgage Global.

Ms. Martin said repeat buyers, however, have benefited “massively” from the runup in prices over the past four years, and will be able to use their equity from any sale to help with another purchase.

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