Canadian Interest Rates Echo 2001, Yet Home Costs Surpass Incomes Thrice Over: BMO

The landscape of Canadian housing affordability presents a challenging outlook for the younger generation. BMO's recent insights into affordability illustrate the toughest home-buying environment since the housing bubble of the late 1980s. While the slight uptick in interest rates hasn't been a boon, the main concern remains: Interest rates are reminiscent of 2001, but home prices have accelerated three times faster than wages.

1988 Was The Last Time Canadian Real Estate Was This Unaffordable

It’s been nearly two generations since Canadians grappled with such high housing costs. In the expansive Greater Toronto area, the cost of home ownership consumes a staggering 79% of a median household’s earnings. This isn’t about prime downtown real estate; it's the average cost across this vast economic zone, suburbs included.

Sal Guatieri, the chief economist at BMO, mentions, “In Toronto, that amount only covers your mortgage. Expect another 8% of your income to go towards property taxes, heating, condo charges, and other housing-related expenses.”

For the majority of Canadians, the picture isn’t much brighter. For instance, in Vancouver, a median household will find 78% of their income consumed by a house. And while one might expect relief in smaller cities, the reality is slightly better but still daunting. Nationally, the average stands at 39% of income for just the mortgage. This doesn’t include other ownership expenses that further amplify the costs.

Government officials may emphasize the enhancements in living costs, but the housing scenario only deteriorates. As Guatieri comments, “Recent data suggests that the affordability issue has exacerbated over the last year due to interest rate hikes and a surge in prices.”

Source: BMO Economic Research.

The Challenge of the Stress Test

The stress test – designed to assess if borrowers can manage higher rates – has added another layer of complexity. It’s been instrumental during the recent rate increases, curtailing overborrowing. But when combined with already lofty income prerequisites, cities like Toronto become even more elusive.

As Guatieri states, “If one qualifies at an interest rate two percentage points higher than the contracted rate, it equates to 94% of annual income on mortgage service costs. This is significantly higher than the 39% limit set by federally regulated lenders, which also factors in other housing expenses.”

2001 Saw Similar Interest Rates, But Housing Affordability Was Different

While interest rates now mirror those of 2001, the affordability game has changed. BMO's data shows that in 2001, a home cost a more manageable 29% of income. The reason for today's disparity? A skewed emphasis on non-productive growth in Canada.

Guatieri elaborates, “The key distinction is the pace at which prices have surged, nearly tripling compared to incomes, increasing the ratio from four times to eleven times the income.”

Canada’s Desirable Locations Come With Hefty Price Tags

Despite the national rise in home prices, some markets remain accessible. However, the concern is that these affordable regions don’t house the majority. Guatieri points out, “One-fourth of Canadians reside in two regions that are unattainable for most, with several other areas seeing a sharp price hike in recent years.”

He further suggests, “For a blend of city life and affordability, consider cities like Montreal, Calgary, or Ottawa. Here, mortgages eat up only a third of incomes, and the stress test isn’t a hurdle for many.” Moreover, places like Saskatoon, Regina, Winnipeg, Edmonton, Quebec City, London, and St. John’s have housing costs at about 20% of median incomes. These regions are attractive for investors due to their lower entry costs, facilitating a potentially profitable rental venture.

Will A Reduction In Interest Rates Aid Affordability? BMO Weighs In

Hopes for an ease in housing costs shouldn't be pinned on a rate reduction. Guatieri states, “Only a drastic drop in interest rates combined with wages outpacing housing prices over an extended duration can provide relief.”

However, this notion has a flaw – historically, reduced rates haven’t always translated to increased affordability. Research by the Bank of Canada demonstrates that in the last two decades, falling rates have spurred price hikes instead of making homes more attainable.

Further studies by the Dutch central bank reveal that lower rates tend to benefit the wealthier segments of society. Wealthy households gain more leverage from these low rates. Plus, with decreased input costs, investing in properties becomes more feasible, fueling demand.

In conclusion, the recent history of low-interest rates resulting in a surge of investors and diminished affordability seems to have faded from memory, even though its impacts are felt strongly today.