As mortgage interest rates continue to climb higher, one economist predicts that growing rates will shake up Canada’s housing sector. Photo: karamysh / Adobe Stock

The Bank of Canada is expected to make its next interest rate announcement on June 1st. The fourth announcement of 2022, which could bring about another increase to the target for the overnight rate, will follow the largest hike to interest rates in over 20 years.

As mortgage interest rates continue to climb higher, one economist predicts that growing rates will shake up Canada’s housing sector, pushing some first-time homebuyers out of the market while lowering home prices.

In a recent Desjardins Economics Study report, senior economist Hélène Bégin stated that a hike to mortgage rates will “help cool down the resale market,” and will become “more important than projected a few months ago.”

“Lower demand from first-time buyers, who generally have more limited budgets, will gradually ease price pressure,” said Bégin. “Overbidding is expected to eventually recede, helping prices stabilize somewhat by the end of the year. Prices could even drop next year in Quebec and Ontario as households feel a bigger pinch from interest rate hikes.”

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As of Q1-2022, markets in Quebec and Ontario have experienced average annual price growth within the 10 to 30 per cent range. Despite significant yearly gains, monthly increases appear to now be weakening in both provinces.

The market remains tight as buyers rush forward to take advantage of lower interest rates, but shallow home inventories still persist. Price pressures will therefore continue for a few more months, rising more than10 per cent again this year in Quebec and Ontario before falling in 2023, according to the report.

“Next year, it seems inevitable that prices will fall in both provinces,” said Bégin. “Lower demand will mean fewer multiple offer situations and an end to the overbidding that’s been happening almost everywhere. Sales prices are expected to come back toward properties’ real value, i.e., lower than the peak prices we saw at the height of the frenzy.”

Rising rates may push newer buyers from market

As mortgage rates rise, Bégin said that home prices are anticipated to fall next year as Canadians feel the pinch of higher rates. Although a serious price correction might not be on the cards, things will depend on how far and how quickly the cost of borrowing increases.

As rates go higher, the pool of homebuyers is also predicted to shrink, especially younger purchasers who will be hit the hardest by deteriorating affordability.

Bégin explained that although first-time buyers accounted for nearly half of residential sales in Canada last year, this buying group will become less active, marking a “turning point for the resale market.” Even the 2022 Budget’s announcement of a tax‑free First Home Savings Account and the doubling of the home buyers’ tax credit won’t come into effect until 2023, meaning it will take time for these policies to have an impact.

“In the short term, home ownership could be a big reach for many,” said Bégin. “The fact that first‑time buyers will be less active will inevitably ease price pressure since there are more of them than experienced home buyers and investors.”

Number of new homes being built this year may drop

In Q1-2022, housing starts slowed down. A lack of developable land, higher costs to build and supply chain woes will mean less building post-2021, Bégin noted. For example, housing starts are down significantly in Quebec’s urban centres and smaller communities.

Rising rates will accelerate falling housing starts, which could drop by about 40 per cent in 2022. However, construction starts for rental homes may not feel as big of an impact.

“Rental housing starts, on the other hand, should stay on pace. Low vacancy rates in most Quebec and Ontario markets along with higher barriers to ownership and more immigration, will increase demand for rental housing,” said Bégin.

Rate hikes to limit new buyers, affect fixed and variable borrowers

After a stretch of red-hot real estate activity, higher interest rates are anticipated to make a difference in the marketplace.

Last fall, fixed mortgage rates started to move up as a result of investor inflation expectations on the bond market, and are forecasted to keep trending upwards over the coming business quarters. Effective rates on mortgages with a five-year term or greater may surpass four per cent soon, around double the prevailing rate at the height of the pandemic, according to Bégin.

“Given today’s high housing prices, this will limit the number of new buyers on the market,” said the senior economist. “Existing homeowners will feel the effect when their mortgage matures if there’s a big difference between their initial rate and the rate available at renewal.”

Graph: Desjardins, Economic Studies / Spotlight on Housing

For variable mortgages, rates are expected to hit around four per cent by the end of 2022. With inflation now reaching levels not seen since the 1990s, the BoC will have to become more forceful to get things on track, said Bégin. In March, the overnight rate was set at 0.25 per cent and has risen 75 basis points since. By year’s end, the overnight rate is predicted to hit two per cent.

As variable rates rise, less of a borrower’s money is paid towards their mortgage principal. Therefore, homeowners will need to refinance more of their mortgage at renewal, Bégin explained. More households may also have trouble passing the mortgage stress test. Under current rules, borrowers must qualify by either the rate offered by their lender plus two per cent, or 5.25 per cent, whichever is higher. As mortgage rates rise, the minimum qualifying threshold could be more than 5.25 per cent.

“Rising fixed and variable rates will be felt by current homeowners, but even more so by first-time buyers who will be facing much larger monthly payments,” said Bégin.

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