CBC News

Canada’s housing market would be more than able to withstand a modest 2% increase in mortgage rates as long as it’s implemented slowly, over a year or two, BMO economist Robert Kavcic says.

Comment: Which is what I have been saying for years.

In a report Friday, Kavcic runs some numbers trying to gauge the impact of what would happen if Canadian mortgage rates increased by about 2%.

The housing market has been pumping out strong gains for more than a decade, which has caused policymakers and many private-sector observers to worry that prices are too high, and think a correction has to be coming — especially once mortgage rates return to more normal levels.

But there isn’t necessarily anything to worry about in a modest, 2% hike, Kavcic finds — depending on how it’s implemented.

Most first-time homebuyers in Canada choose a five-year fixed-rate mortgage amortized over 25 years, so that’s the baseline that Kavcic works from. (Currently, the average posted mortgage rate for that type of mortgage is something around 3%.)

In order to gauge affordability, Kavcic looks at the same metric that financial planners say buyers should pay attention to when buying a home — the percentage of the buyer’s income that gets eaten up by housing. (A healthy level is when 25% to 30% of one’s income is spent on housing. Borrowers historically run into trouble when that ratio hits 35% or higher.)

Kavcic says if mortgage rates jumped by two percentage points overnight (say, to an average of around 5%) the impact on the housing market would be dramatic, as people would suddenly finding themselves paying a dangerously high percentage of their income on housing.

Comment: But it doesn’t mean that everyone currently paying a mortgage has their monthly payments rise. It matters at renewal time. And they can always add to their amortization, which lowers their payments. If you had a 25-year mortgage for 5 years, typically you renew at a 20-year amortization. If that hurts with the higher rates, then you can bump back to a 25-year amortization and mitigate the impact of the higher rate.

“If we were to get that increase overnight, housing valuations … would be stretched to levels that preceded significant corrections in the past,” Kavcic says.

Rising incomes, rising prices

But if that two-percentage-point increase gets implemented a little more slowly, giving incomes times to catch up, the impact is much less dramatic. If the hike is implemented gradually, until 2016, the income ratio doesn’t go into the danger zone, he says.

As well, if the hike is even smaller, something around 1%, there could actually plenty of room for prices to go up further. “If that increase happens gradually over the next two years, if at all, it’s a much different story,” Kavcic said.

His assumptions are based on incomes rising by a modest 3% per year over that time, a reasonable assumption based on the 3.1% pace that Statistics Canada says they’re increasing by right now.

Comment: That is what everyone forgets. If rates rise, that means the economy is rising. And when that happens, incomes rise. Any potential interest rate rise is tied to incomes rising as well.

The latest data from the Canadian Real Estate Association shows the average Canadian home price hit $409,708 in April, up more than 7.6% in the past year.

Most experts think the days of outsized gains have to come to an end some day soon, but as Kavcic’s analysis shows, mortgage rates ticking higher but slowly should be no reason to spark a major sell-off.

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Contact Laurin Jeffrey for more information – 416-388-1960

Laurin Jeffrey is a Toronto real estate agent with Century 21 Regal Realty.
He did not write these articles, he just reproduces them here for people who
are interested in Toronto real estate. He does not work for any builders.
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