‘This will remove buyers from the market’: Higher interest rates on Wednesday will help tame frothy housing prices, experts say

Canada’s central bankers may pour water on a red-hot housing market on Wednesday if they announce widely expected interest rate hikes not seen in years.

As the Bank of Canada wrestles with soaring inflation, which hit a 30-year high of 5.7 per cent in February, Bay Street economists broadly anticipate that Governor Tiff Macklem and his team of economists will raise the bank’s overnight interest rate by 0.5 per cent, doubling the current rate from 0.5 per cent to one per cent.

That may not sound like much — given historical rates that until the 2008 financial crisis typically sat above two per cent — but the decision would mark the bank’s most aggressive effort to curb consumer prices in more than two decades, and mortgage rate analysts say it will likely to help tame a frenzied real estate market.

“Anyone currently shopping for a home will be less enthusiastic to bid a high price when the cost to finance the home has gone up. This will remove some buyers from the market,” said James Laird, co-founder of Ratehub.ca and president of CanWise Financial mortgage broker.

Like most monetary policy decisions, the choice presents an economic Catch-22: the higher the rate, the harder it is to borrow money, meaning prospective homebuyers will find it harder to get financing while current homeowners pay more for their mortgages.

Already, Laird noted, mortgage rates at Canada’s big banks have been rising consistently in the last few weeks as lenders account for coming rate hikes.

Based on Ratehub.ca’s mortgage payment calculator, a homeowner who put a 10 per cent down payment on an $800,000 home with a five-year variable rate of 1.15 per cent (amortized over 25 years) presently pays a monthly mortgage of $2,847.

Under the Bank of Canada’s expected 0.5 per cent increase, the homeowner’s monthly mortgage payment will increase to $3,019, meaning the homeowner will pay $2,064 more per year on their mortgage.

And the rate hikes won’t stop there, economists say. Over the next year, the bank is widely expected to continuously raise the overnight interest rate until it reaches two per cent by the end of the year — the highest level in more than a decade.

“Anyone with a variable rate mortgage should understand what their payment will be with a 50 basis point increase next week and they should budget for additional rate increases totaling one to two per cent for the remainder of the year,” Laird said.

Among those who will bear the brunt of rate hikes are potential first-time homebuyers who must pass the federal government’s so-called “stress test” to qualify for a government-backed mortgage.

The test requires mortgage applicants to provide they can handle higher interest rates so as not to default on payments.

Leah Zlatkin, a mortgage broker with lowestrates.ca, said the recent rate hikes represent a “turning point” for those prospective buyers.

Mortgage rates are now high enough that many potential buyers will have to qualify at percentages above the stress test, which is presently 5.25 per cent or two per cent above the offered mortgage rate, whichever is higher, Zlatkin said.

“Many homebuyers are not aware of this nuance and it would affect their affordability even if home prices were to slow down over the next year,” Zlatkin said.

The Bank of Canada kept borrowing costs near record lows during the pandemic as the economy teetered on the edge of recession, but mounting inflationary pressures brought about by supply chain challenges and high energy costs have prompted Macklem and his team to adopt a tougher stance.

Macklem has publicly expressed concern over today’s inflation rates, which are well above the bank’s target of two per cent and offer a grim reminder of how inflationary pressures spiraled in the 1970s and ’80s.

“The economy just does not work well when inflation expectations become unmoored,” Macklem said last month.

The housing market is at the heart of Canada’s major inflationary pressures, where the typical home price has surged 52 per cent to $868,400 over the past two years, according to the Canadian Real Estate Association.

But rate hikes alone will not solve a sweeping affordability crisis, experts have noted. The real estate market’s increasing exclusivity has been attributed to a broad range of factors beyond record-low interest rates, including a lack of housing supply, foreign buyer activity, speculative buyers and investors, and even white collar crime.

Nonetheless, Laird says the anticipated rate hikes will help limit demand and reduce competition for housing, at least to an extent.

“A 50 basis point increase will certainly have a cooling effect on home prices around the country” he said.


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