How Do High Interest Rates Affect The Housing Market in Canada?

How Do High Interest Rates Affect The Housing Market in Canada
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How Do High Interest Rates Affect the Housing Market?

Interest rates play a major role in the housing market. When interest rates rise, it affects homebuyers, homeowners, renters, builders, and the economy as a whole. Let’s dive into the factors that influence interest rates and how rate hikes impact different players in real estate.

What Drives Changes in Interest Rates?

Interest rates reflect the cost of borrowing money. Many factors determine the rise and fall of rates.

The 10-Year Treasury Yield

Fixed mortgage rates closely track the yield on 10-year Treasury notes. As Treasury yields rise, mortgage rates follow. Investors drive these yields up when they anticipate higher inflation and sell bonds, pushing bond prices down and yields up.

Inflation

As the prices of goods and services increase, lenders must charge higher interest rates. Otherwise, inflation would lower their real returns. The Fed boosts rates when inflation rises to maintain positive real returns for lenders.

Employment Trends

Lenders worry about rising unemployment leading to more loan defaults. To compensate for this risk, they charge higher rates, making it harder to qualify for loans. The Fed also hikes rates when unemployment falls too low, risking an overheated economy and spiraling inflation.

How Do Higher Interest Rates Impact Homebuyers?

Higher mortgage rates decrease affordability for homebuyers. Here’s how rate hikes hit them.

Reduced Purchasing Power

With higher mortgage rates, buyers must pay more interest over the loan term. On a $300,000 loan, monthly principal and interest payments rise from $1,265 at 3% to $1,610 at 6% – an extra $4,200 per year. This reduces purchasing power, forcing buyers to lower their budgets or wait to buy.

Affordability Challenges

Not only do buyers pay more interest with higher rates, but it’s also harder to qualify for loans. Lenders ensure borrowers have enough income to make higher monthly payments. Tighter loan standards shrink the pool of eligible buyers.

Less Motivation to Buy Quickly

When rates seem likely to keep rising, buyers lose incentive to rush into purchases. Instead of competing in bidding wars, more adopt a wait-and-see approach. This cools demand, giving sellers less leverage to demand top dollar.

Shift From Variable to Fixed Rates

In Canada, some buyers opt for variable-rate mortgages when fixed rates look high. But as variable rates rise with the Bank of Canada’s increases, more switch to fixed rates for predictability. This causes a spike in fixed mortgage demand.

How Do Higher Rates Affect Existing Homeowners?

Current homeowners also feel the pinch of rising rates, especially through higher mortgage payments.

Renewal Shock

Homeowners on fixed mortgages face “renewal shock” when rates are much higher as their terms expire. Monthly payments can jump hundreds of dollars at renewal. This strains budgets for other expenses.

Trouble Refinancing

High rates deter refinancing. Existing mortgages at lower fixed rates cannot be replaced with new ones at current higher rates. Variable-rate mortgages also become too expensive to refinance.

Affordability Challenges

Like new homebuyers, existing owners struggle with affordability at renewal due to elevated fixed rates. Variable-rate homeowners get hit with unplanned budget crunches as payments increase along with hikes.

Home Equity Impact

Rising rates slow home price appreciation. Owners counting on large price gains to build equity through refinancing find less funds available than expected. Less equity also limits options to consolidate high-interest debts.

Did you know over 75% of homeowners age 45-65 planned to use home equity to fund at least part of their retirement, according to a survey by Richard Morrison? If true, reduced equity gains from high rates could derail many retirement plans.

How Do Higher Interest Rates Affect Renters?

Renters don’t directly pay mortgage rates but still feel their impact. As rates rise, rental demand increases, driving up rents.

Shrinking Homeownership Affordability

As higher rates limit home affordability, more renters get shut out of the buyer’s market. They must keep renting while they save up larger down payments and improve credit to offset higher mortgage payments. Increased rental demand allows landlords to hike rents.

Competition for Rentals

Tight resale home inventory further swells rental demand. Aspiring first-time buyers lose bidding wars and look to rent instead. Bodies competing for each rental drive vacancy rates down, spurring rising rents.

Property Investor Impact

High rates hit property investors with higher borrowing costs as they acquire rental units. Landlords pass these expenses to tenants through rent increases to maintain profitability. Supply falters as rising rates scare off investors.

Reduced Mobility

Surging rents trap renters in place. They cannot afford the upfront costs of moving such as first and last months’ rent and security deposits at new units with spiked rents. Renters stay put and renew leases at rising rents.

How Do Higher Rates Affect Builders and Real Estate Investors?

Builders and real estate investors also navigate challenges in a high interest rate environment.

Constrained New Construction

Builders rely on borrowed capital to finance new housing projects. As rates rise, borrowing costs cut into builder profits from new construction. Builders scale back projects, constraining supply increases.

Shifting Housing Preferences

High rates reduce buyer budgets and push preferences toward smaller, more affordable new homes. Builders adapt plans to meet demand for modest homes, condos, and rental apartments instead of large luxury houses.

Investment Property Headwinds

Investors pay higher borrowing costs to acquire rental housing units when rates rise. Reduced investor activity limits additions to rental supply. Meanwhile, rising rates erode investor returns through higher interest payments.

Real Estate Business Risks

Private real estate companies rely on ample low-cost financing to fund operations and expansion. Rate hikes add business risk by increasing their cost of capital. Some projects or growth plans may get shelved due to reduced returns.

How Does the Broader Economy Handle Rate Hikes?

The housing market doesn’t exist in a bubble. Interest rate changes influence the broader economy too.

Slower Economic Growth

Higher rates purposefully slow the economy by making borrowing more expensive. Consumers and businesses cut back on spending, investment, and expansion. This eases pressure on overstretched supply chains.

Fighting Inflation

The Fed boosts rates to tame inflation by reducing demand. As businesses and consumers pull back activity, prices should stabilize instead of spiraling upward. Tighter credit also limits wage growth tied to inflation.

Risk of Recession

Many economists warn that too many rate hikes could lead to recession. Significant housing market declines have preceded past recessions. Slumping construction jobs add to unemployment. But a recession may be necessary medicine for decades-high inflation.

The Interest Rate Balancing Act

Like walking a tightrope, the Fed faces tremendous pressure to strike the right balance with interest rate policy. Raising rates too slowly risks runaway inflation, while hiking too aggressively may induce unnecessary recession. The housing market feels the fluctuations either way.

After enjoying the gains from low interest rates for years, the housing sector now braces for a bumpy landing. But what goes up must come down. 

FAQs:

Q: How do rising interest rates affect the housing market in Canada?

A: Rising interest rates can have a significant impact on the housing market in Canada. As interest rates rise, it becomes more expensive to borrow money, including mortgage loans. This can result in higher monthly mortgage payments for homeowners.

Q: What is the relationship between interest rates and house prices?

A: There is an inverse relationship between interest rates and house prices. When interest rates increase, it becomes more expensive to obtain a mortgage, which can decrease demand for housing. As a result, home prices may start to decline. On the other hand, when interest rates decrease, borrowing costs become more affordable, leading to increased demand for housing and potentially driving up home prices.

Q: How do rising interest rates impact the Canadian real estate market?

A: Rising interest rates can have several impacts on the Canadian real estate market. Firstly, it can affect the affordability of homes, making it more challenging for potential buyers to enter the market or qualify for loans. Secondly, it can lead to a decrease in demand for housing as buyers may opt to wait for interest rates to decrease again. Lastly, rising interest rates can also result in a slowdown in new construction activity as developers may be less inclined to undertake projects when borrowing costs are higher.

Q: What is the Bank of Canada’s role in setting interest rates?

A: The Bank of Canada is responsible for setting the key interest rate in Canada, also known as the overnight rate. This rate influences the borrowing costs for financial institutions and ultimately affects the interest rates that consumers and businesses pay on loans and mortgages. The Bank of Canada adjusts the key interest rate based on various economic factors, including inflation, economic growth, and financial stability.

Q: How do lower interest rates impact buying a home?

A: Lower interest rates can make buying a home more affordable. When interest rates are low, mortgage payments are lower, which can increase the purchasing power of potential buyers. Lower interest rates can also make it easier for individuals to qualify for mortgages, as their debt-to-income ratio may be more favorable. Additionally, lower interest rates can stimulate demand for housing, potentially leading to increased competition and higher home prices.

Q: What is the impact of rising interest rates on mortgage payments?

A: Rising interest rates can result in higher monthly mortgage payments. As interest rates increase, the cost of borrowing money also rises, which directly affects the interest portion of a mortgage payment. This, in turn, increases the overall monthly payment that homeowners need to make to their mortgage lender. Homeowners with adjustable-rate mortgages are particularly vulnerable to rising interest rates, as their monthly payments can increase when rates go up.

Q: How do rising interest rates affect the demand for housing?

A: Rising interest rates can have a dampening effect on the demand for housing. When interest rates increase, the cost of borrowing money to finance a home purchase also rises. This can make homes less affordable for buyers, especially those on the margin of qualifying for a mortgage. As a result, potential buyers may postpone their home purchase or seek more affordable options, leading to a decrease in demand for housing.

Q: Can rising interest rates impact the availability of mortgages?

A: Yes, rising interest rates can impact the availability of mortgages. As interest rates rise, lenders may tighten their lending criteria and become more selective in the borrowers they approve for loans. This is because higher interest rates increase the risk of loan default, and lenders want to mitigate this risk. As a result, some potential buyers may find it more challenging to qualify for a mortgage or may be offered less favorable loan terms.

Q: What are the potential consequences of interest rate hikes in the housing market?

A: Interest rate hikes can have several consequences in the housing market. Firstly, they can lead to a slowdown in home sales as potential buyers may be deterred by the higher borrowing costs. This can result in decreased demand, leading to downward pressure on house prices. Secondly, interest rate hikes can make it more challenging for homeowners to refinance their mortgages or access home equity loans. Lastly, rising interest rates can impact affordability and may contribute to increased levels of mortgage stress and default.

Q: How do interest rates on 30-year fixed mortgages impact the housing market?

A: Interest rates on 30-year fixed mortgages play a significant role in the housing market. These rates determine the borrowing costs for homebuyers who opt for long-term fixed-rate mortgages. When interest rates on these mortgages are low, it can make homes more affordable and increase demand in the housing market. Conversely, when the rates increase, it can decrease demand and put downward pressure on home prices.

Conclusion

High interest rates can have a significant impact on the housing market. When interest rates rise, it becomes more expensive for borrowers to finance their homes, as mortgage interest rates increase. This can deter prospective buyers from entering the Canadian housing market, leading to a decrease in demand for homes.

Consequently, this decrease in demand can result in a shift from a seller’s market to a buyer’s market, where buyers have more negotiating power.

Additionally, rising interest rates may encourage homeowners to stay in their current homes rather than sell, as they are less incentivized to take on new mortgages with higher interest rates. 

Overall, high interest rates can slow down the growth of the Canadian housing market and make it more difficult for individuals looking to buy or sell their homes.

However, it is important to note that interest rates are still relatively low in Canada, and despite recent increases, mortgage rates remain relatively affordable. 

Sources
https://www.bankofcanada.ca/2023/02/higher-interest-rates-are-working/
https://www.bnnbloomberg.ca/canada-s-higher-interest-rates-cause-borrowers-pain-1.1891637


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