Soaring Interest Rates a Big Blow for First-Time Buyers

The red-hot Canadian real estate market is finally cooling down thanks to higher interest rates, and is poised to experience some stabilization after the unprecedented boom of the last two years. Is this a terrific opportunity for households looking to purchase a home, or is ownership still out of reach for many Canadian families?

Canada’s housing sector had been electric throughout the coronavirus pandemic, from skyrocketing real estate valuations to exceptional sales activity. It isn’t easy to find another comparable period in the Canada’s history or perhaps envision another span like it in the future – although markets are cyclical.

But while many Canadian families established generational wealth throughout the COVID-19 public health crisis, the frenzy left too many prospective homeowners sitting on the sidelines and unable to purchase a home. Try as they did, many could not get a foot into the housing market.

Times may be changing, however.

Now that the sizzling housing market is being doused by rising interest rates and broader market uncertainty, demand is sliding and record-breaking price growth has moderated, offering some reprieve to buyers trying to find something within their budget.

However, as prices remain elevated from the COVID boom, many families are still unable to achieve the dream of home ownership. Suffice it to say, higher interest rates are offsetting any drop in housing prices.

Soaring Interest Rates a Big Blow for First-Time Buyers

According to the Canadian Real Estate Association (CREA), the national average home price tumbled 1.8 per cent month-over-month in June to below $666,000. This figure is much higher in the British Columbia and Ontario real estate markets, with average prices north of $1 million.

It is estimated that when Toronto and Vancouver are removed from the equation, the national average price is trimmed by more than $114,000.

Despite the Canadian real estate market experiencing some easing, prices remain well above their pre-pandemic levels, and the mortgage taken on by first-time homebuyers in order to purchase at these price points is immense. Moreover, the interest rates attached to these mortgages will keep rising as the Bank of Canada (BoC) continues its upward trajectory, making any savings from easing prices negligible.

“One important feature of the market right now that isn’t getting enough attention is the difference in mortgage qualification criteria between fixed and variable, because while variable rates adjust in real-time, fixed rates have already priced in most of what the Bank of Canada is expected to do over the balance of 2022,” said Shaun Cathcart, CREA’s Senior Economist, in a statement.

“As such, it’s no surprise to see people piling into variable rate mortgages at record levels, but probably not for the reasons they may have chosen them in the past. It’s because the 200 basis points plus the contract rate element of the stress test has, just since April, become much more difficult to pass if you want a fixed-rate mortgage. A strict stress test made sense when rates were at a record-low, but policymakers may want to assess if it continues to meet its policy objectives now that fixed mortgage rates are back at more normal levels.”

Looking Ahead at the Canadian Real Estate Market

The BoC has been on a tightening campaign this year. As part of the central bank’s effort to fight rampant price inflation, the institution has been raising interest rates faster than some of its counterparts.

During the July policy meeting, the BoC pulled the trigger on a full point rate hike, bringing the target rate to 2.5 per cent. The last time the central bank made a similar move was in 1998. It also surprised market analysts, who pencilled in a 75-basis-point increase.

Based on the various Monetary Policy Reports and statements from BoC officials, it is more than likely that the institution is not slowing down its pace of rate hikes in 2022. This, of course, is expected to weigh on economic growth since a rising-rate environment will cool pent-up demand.

These market trends are leading some real estate experts to forecast a housing industry that will go through a sharp correction heading into 2023, while others are stressing the need to read recent market data in the right context.

A growing number of financial institutions are turning more bearish on the housing sector amid a more aggressive Bank of Canada.

Desjardins expects the real estate market to weaken by 25 per cent in the coming months, although prices will remain above their pre-pandemic levels by the end of next year. It also noted that the most significant price reversals would occur in Atlantic Canada, adding that the overall real estate market will stabilize by late 20023.

The Royal Bank of Canada (RBC) anticipates the real estate market correction to be the biggest in half a century. At the same time, RBC economists are urging the public not to think this is a crash.

“We expect home resales will fall another 17% in Canada by early next year after dropping 19 per cent in the second quarter and 13 per cent between the first quarter of 2021 and first quarter of 2022,” the bank wrote.

TD Economics projects a 33-per-cent “peak-to-trough decline in Canadian home sales” from the first quarter of 2022 to the first quarter of 2023.

Overall, Canada’s real estate market is on track for a notable slowdown. Still, interest rates may eliminate much of the savings homebuyers had hoped for, even at the beginning of the pandemic.