The Bank of Canada's (BoC) surprising 100 basis points rate hike has taken a hammer to an already cracking housing market, a new report from BMO Economics says.
The rate hike, announced last week, was shockingly higher than the anticipated 75 basis point rise. It also marked the largest interest rate increase since 1998, and brought the BoC's total percentage increase this year to 2.25%. Even before last week's announcement, Canadians were already feeling the effects of the three earlier rate hikes, especially those in Ontario and British Columbia where the high price of real estate makes residents more sensitive to rate changes.
Variable mortgage rates, which accounted for more than 50% of new lending beginning earlier this year, now sit around 4%, up from 1.5% at the beginning of the year. Five-year fixed rates, which were more popular earlier in 2021 when they were also below the 2% mark, continue to hover around 5%.
"The mortgage yield curve is flattening quickly, but the broad housing market is now being priced with cost of funds around 4.5% on average -- a major shift in a short period of time," the report reads.
The cost of borrowing jumping from 1.5% to around 4.5% in just six months is a "massive pill for the market to swallow," the report notes. Although 4.5% mortgage rates are still historically low compared to the double-digit rates seen at the tail end of the 1980s boom, it's the rapid change that matters.
"In fact, going from 1.5% to 4.5% on the same loan value would crank the monthly mortgage payment by almost 40%, making the current episode an even more abrupt shift than the late-1980s after adjusting for income levels," the report reads.
For borrowers who are just now coming off a five-year fixed rate, they'll see a payment increase of roughly 15%. For variable mortgage borrowers, however, things get a little more risky. Although the majority of these borrowers are theoretically protected by having fixed payments, the variable rate jump from 1.5% to 4% would effectively increase their amortization from 25 years to 45 years. If BoC implements another 50 basis-point hike in September, it would take that amortization period to over 60 years, meaning many borrowers would reach the point where their payments are no longer bringing down the principal.
"Each mortgage will have its own unique terms with respect to when payments start to move higher, but for those that caught the low in variable rates, we’ll probably be there soon," the report says.
For Canadians who haven't yet taken on a mortgage but are trying to purchase property, they're being hit hard by new stress test parameters that are cutting into their buying power. A buyer looking to qualify for a variable rate mortgage, which is now sitting around 4%, will have to qualify at 6%. Before the hike, they were qualifying at 5.25%. For fixed-rate borrowers, they'll now have to qualify around 7%.
As the ability to buy dwindles, so too have home sales in markets all across Canada. Falling prices have already been seen in many markets, especially those in Ontario, and now, a growing number of Canadians expect prices to keep falling. A recent Nanos poll found that one-third of Canadians expect prices to fall -- a significant change from the low of 5%. At the same time, just 30% of Canadians expect prices to keep going up, which is down from almost 70% at the peak of the pandemic boom.
"We’ve argued all along that there was a major behavioural aspect to what was happening in Canadian housing, where acute price gains were driven by FOMO, speculation and investment activity," the report reads. "Indeed, the proof is that even just an initial nudge in interest rates was enough to crack expectations and trigger a correction. The latest move by the Bank of Canada will wash away any remaining froth."
