The severe inflation coming out of the pandemic, compounded by unstable world events is elevating the cost of almost everything: grocery prices, gas prices, retail purchases, wages, etc., etc., etc.
Housing is not one of them, though. Housing inflation occurred during the pandemic, and a tiny interest rate hike ended that. So, why are we getting slammed with high mortgage rates now?
Like most things, it’s the unintended consequences of government policies that create a mess.
In January 2020, just before the pandemic shut us down, the Bank of Canada rate was 1.75% and the major banks’ prime rates were 3.95%. Today, the rates are 3.25% and 5.45% respectively. We’re still below the historical average, though, of around 4% and 5.5%, respectively, but the gap between the two has widened.
When the pandemic hit, the Bank of Canada, in step with banks around the world, lowered their rates to the bare minimum to stimulate an economy that was otherwise close to dead, and to ease the burden of those with debt to manage while unable to work. It was fair: if the government was forcing people to not have an income, they owed it to them to ease the burden of not working.
Little did they imagine that the low interest rates would initiate a boom in housing sales, leading to rapid price escalation. With the low interest rates, people could qualify for a larger mortgage than previously.
Add the fact that many (not the newly unemployed) who had money saved up for vacations they now couldn’t take, spent that money instead on upgrading their housing, either by renovating or by moving up in the market. Others now working from home needed larger, or different, living arrangements, and contributed to the sell-and-buy cycle. Still others, seeing what was happening, jumped into the market before it got carried away further, accelerating the upward price spiral.
Supply chain issues contributed to the pattern. Lumber prices, for example, went through the roof at the height of the squeeze. One lumber yard manager told me, “Prices better come back down slowly; otherwise, we’ll all go under.”
To counter the housing frenzy, and other inflationary pressures, the rates have steadily been rising since the start of the year (a total of 3%, in five stages). Another 1% increase is still anticipated.
The rebalancing of the economy with a return to historic rates was probably initiated way too late, and hence done too quickly, and the Bank of Canada (the government), has taken immense criticism for that. But the same thing happened in every developed country, with the same criticism, and our government’s only response seems to be that they were in line with other nations. (You judge whether that is a valid response.)
The housing escalation took the hit almost immediately. By April, after barely a 1% hike in interest rates housing prices had already stabilized and were soon falling. But everything else was now rising, and interest rates were contributing to that rise. (By the way, despite their protests to the contrary, governments like that, because inflation makes their massive debts more manageable.)
The bottom line is that housing prices have stabilized and even come down a little, but the massive inflation in the rest of the economy is causing interest rates to continue their rise despite their contribution to further inflation. With inflation now easing, the only justification now seems to be to support the Canadian dollar against the US dollar. Despite that, we’re still losing ground (but not as much as most countries.)
Here is how it affects rent 2 own.
The effect of interest rate increases more than off-sets the small decline in housing prices. Therefore, it is even harder now to get into the housing market than before. During the height of the pandemic, rent-2-own clients could qualify for property values approximately 4.5 times their gross annual income. Now they qualify for only about 4 times that income, a 12.5% drop. Have properties, on average, decreased by 12.5%? Perhaps from their peak, but certainly not from where they started the run-up during the pandemic. They’re still far above that baseline.
The government could ease the dilemma by cancelling the “stress test.” That’s the measure they mandated about 5 years ago that required borrowers to qualify at a mortgage rate 2% above their actual rate (or 4.79%, whichever was higher), to avoid getting into trouble when rates went up. At the time, that lopped off about 20% of the value of property a buyer could qualify for. Someone who, prior to that, had qualified for a $750,000 property now suddenly qualified for only a $600,000 property. We had been qualifying clients at 5+ times their income.
During the pandemic, when mortgage rates were between 1 and 2%, the stress test was actually raised to a minimum of 5.25% (Was that a fore-shadowing of anticipated rapid rate hikes coming out of the pandemic?).
Now, with the prime bank rates at 5.45%, and with the stress test still in effect, buyers must qualify for a rate of 7.45% to get that 5.45% rate. Is that gap still justified at today’s rates?
I think not.
But, because it’s still there, we’ve had to make that drop from 4.5x to 4x income.
It means that everyone needs to lower their expectations. It now takes an annual income of nearly $200,000 to qualify for a single-family home in the Fraser Valley, where very few such properties are still available for under $800,000. It means most potential buyers have to be satisfied with a townhouse or apartment in this part of the world.
Or move further into the interior, where prices, though going through the same cycle, are still considerably lower than those of the West Coast.
But the dream of home ownership doesn’t need to die. It just needs to be adjusted to reflect the reality of the contemporary economy.
