Will rising interest rates bring down house prices? Not by much, experts suggest
How high? How fast?
When it comes to rising interest rates, how high the Bank of Canada raises its benchmark lending rate and how fast it gets there will determine the impact of rate hikes on the Toronto region's white hot housing market and on the national economy where housing is a key driver.
On Wednesday, the Bank of Canada signalled it will raise rates sooner than it had anticipated. Instead of the second half of 2022, analysts say the central bank is now likely to begin lifting its .25 per cent benchmark rate as early as the spring.
Housing experts say most homeowners can withstand a rate rise on their mortgage of 2 per cent in .25 point increments through 2023. Before Wednesday's announcement, the Bank of Nova Scotia was predicting eight such increases in that period.
Economist Will Dunning says many homeowners have already proven they can handle such a hike because they had to pass a mortgage stress test that requires them to financially qualify for 5.25 per cent or the rate they have been offered by their bank plus 2 per cent - whichever is higher.
He thinks the bank should already have raised its overnight lending rate. Lifting the benchmark and adding a half point to five-year mortgages would benefit the economy and, he said, some mortgage rates have already risen.
It takes a little heat out of the economy that's on the verge of overheating, said Dunning, and, It has definitely been overheating in the housing sector."
This week's Bank of Canada release noted that housing activity has moderated, but is expected to remain elevated."
Generally a sign that the economy is overheating, inflation in Canada is expected to hit 5 per cent by the end of year, according to the bank.
Consumers with stress-tested mortgages can handle quite a few quarter-point hikes before they're struggling to pay their mortgage, agreed John Shmuel of Ratesdotca, a site that compares financial products, including mortgages.
The big concern," he said, is that a lot of consumers have been stretching themselves financially with the price of houses recently, and you don't know what happens to someone's finances once they buy that house.
You don't know what kind of debt they're taking on afterwards."
Shmuel says consumer behaviour has shifted as fixed-rate mortgages have risen in the past year. It was almost a no-brainer" to take out a fixed-rate mortgage a year ago when the rates were so similar to traditionally less costly variable loans. It was added peace of mind for about the same cost, he said.
But as the cost of fixed-rate mortgages has risen people have increasingly been moving to variable loans, which opens them up to more risk, he said.
Last October, 87.5 per cent of people looking for mortgage quotes on his company's website chose fixed loans, compared to 13 per cent that went with variable rates. A year later, those who chose fixed mortgage rates were down to 68 per cent with 32 per cent choosing variable rates.
The pandemic has also allowed many consumers to save more money than they have in years, said Royal LePage CEO Phil Soper. Wages are rising, and even though they're not saving as much as they were in spring 2020, Canadians are still probably saving more than they were pre-pandemic.
Soper says it would take a sharp rise in interest rates to significantly impact home prices. Even before the bank's announcement Wednesday, he was predicting a rate hike as early as the spring - something that would be at least partly the result of another uncomfortably buoyant housing market this winter and early spring," leading to continued double-digit price growth.
That runs counter to a blog post by Re/Max published Monday that suggested homeowners thinking of listing might be wise to lock in their profits now." It cited examples of sellers who turned down offers above their asking price only to find that buyers weren't prepared to pay more.
The Ontario housing industry is bracing for a slowdown amid an environment of tight inventory, sky-high prices, and changes to the mortgage stress test," said the company, which says the market is entering a period of adjustment.
Meantime, Soper says the central bank will avoid broadsiding the housing market with a rapid interest rate spike because it's too important to the overall health of the country's economy.
An Altus Group study for the Canadian Real Estate Association says the spinoffs from resale home transactions amount to more than $32 billion a year. The Canadian Home Builders' Association says home construction contributes $81.1 billion annually in wages that go back into the economy.
But Soper said it doesn't take a huge increase in interest rates to change the trajectory of the housing market. Even if rates rose by 1 per cent, it could signal to Canadians to seriously reconsider major asset purchases. What it doesn't do is stop people from buying if they need a roof overhead.
A gradual, moderate increase would bring down house prices marginally for a limited amount of time," said Soper. With demand (for housing) exceeding supply it's hard to imagine a situation where they'd stay down for long."
If prices were to fall, he says it would likely be a situation such as the spring of 2017 or May 2020 - a modest dip in home values after a short decline in sales.
Dunning says consumers are still psychologically absorbing the huge increase in home prices during the pandemic so it's not really baked into people's understanding of their financial situations.
The longer house prices stay at current levels, the more it gets baked in. If you were to assume a 10 per cent retreat in house prices in the spring that would not have mattered at all to consumer confidence," he said.
But if it were to happen two years from now when it's more baked into our thinking, that could have a much bigger negative impact on the housing market because, by then, the homeowner has better internalized their financial position and started spending the money.
Tess Kalinowski is a Toronto-based reporter covering real estate for the Star. Follow her on Twitter: @tesskalinowski