How Key Are Interest Rate Cuts To Restoring Housing Affordability?

Since June, Canadians have witnessed three consecutive rate cuts, bringing the interest rate from 5% to 4.25%. And with more decreases expected for October and December, 2024 is set to be the 'year of rate cuts.'

Even so, the policy interest rate remains higher than ideal, home prices also remain high, and the promise of future rate cuts are keeping would-be-homebuyers on the proverbial sidelines. And this isn't necessarily a bad thing. A gradual increase in buyer activity is expected to keep prices from skyrocketing and should prolong our limited housing inventory.

But what the last few months have shown is that high interest rates clearly aren't the only barrier to housing affordability. So how much should we really be relying on rate cuts, what are the other factors contributing to low affordability, and how long until average Canadians see homeownership as an attainable goal?

Tony Stillo, Director of Economics for Canada at Oxford Economics, says it will take a decade. "We think it's going take roughly a decade to build the houses we reckon are needed to balance supply and demand," he says. "Interest rate cuts will help, but they’re not going to restore affordability."

Tony Stillo/Oxford Economics

It should be noted that Stillo's prediction isn't even based on the target of 3.5 million homes built by 2030 outlined by the Canadian Mortgage and Housing Corporation (CMHC), but on Oxford Economics' findings, which suggest the need for a more modest 4.2 million new dwellings by 2035. Still, he says it won't be until halfway through the next decade that we start to see housing affordability restored, and that's for a few reasons.

Using Oxford Economics' Housing Affordability Index, where a score between 90 and 110 is considered affordable — 100 being the "sweet spot" — current market conditions have landed us with a score of 128. One factor driving this lack of affordability, Stillo explains, is unprecedented population growth.

"I’m surprised [prices] haven’t fallen further [...] but what's happened now is we’ve had a surge in population that was largely unanticipated. I've been doing this for a long time and I've never seen population surge like we’ve seen in the past few years. We've had over a million people per year added," Stillo tells STOREYS. "But without that population surge we would have seen a recession, and that would have probably precipitated layoffs and other bad things, but it would have actually made the housing market correct further. And so the combination of those things kept prices up."

Additionally, a lack of supply threatens to negate affordability improvements achieved by rate cuts and mortgage reforms. "We had thought a couple years ago that prices would fall more, even with a tight supply, but it seems like with the combination of strong underlying demand and tight supply, prices aren't falling like they would have normally," says Stillo.

And demand will only increase as rate cuts grow larger and more frequent and mortgage reforms make buying a home more attainable.

At first, the mortgage reforms, which include greatly expanded eligibility for 30-year mortgage amortizations as well as a price cap increase for insured mortgages, will improve that housing affordability index rating, Stillo says. "We calculate the index rating using the CMHC mortgage guidelines with a 25-year amortization," explains Stillo. "The minute you go to 30-year, it really gives you a lot more room, and we think affordability is going to improve a lot because of that."

But while the new mortgage reforms make homeownership more affordable, the policies might jump the shark when it comes to restoring overall affordability in the long term. "Unfortunately, we’re in an environment of tight supply and [the reforms] are going to lead to higher prices," Stillo says. "We have a view that we’ll see prices rise stronger than what we’d expected for about two years, turning what would have been a roughly seven point improvement in affordability to only about a 1 point improvement. It will unfortunately be undone."

The idea, thought frustrating, is that making homeownership more affordable for first-time homebuyers in the short-term, could lead to an overall increased lack of affordability in the long-term. “All of a sudden more people are like 'wow I can afford a lot more,'" says Stillo. "So we actually think this will permanently raise house prices to the point where it offsets the majority of the benefit.”

Ultimately, Stillo, who predicts the Bank of Canada (BoC) will cut the interest rate by 50 basis points in October and December, says "yes cuts will help, but there's other factors that definitely are at play."

Zooming in on the upcoming rate cuts and their immediate impact on affordability, RBC Economist Rachel Battaglia predicts the relief will be felt gradually, with buyer activity picking up towards the end of this year and over the first half of next year. She also points out that affordability has already improved, though modestly, this year.

Rachel Battaglia/RBC

"We've had the easing of the monetary policy, but we’ve also seen a general stabilization or even cooling in home prices, which has been really important," Battaglia told STOREYS. "Housing ownership costs, which in our measure includes mortgage payments, property taxes, and utilities — that, as a shared median household income in Canada fell to 59% in the second quarter of this year. Which is the lowest the affordability index has been in two years." And that's their Q2 finding, which excludes the impact of the July and September rate cuts.

At the same time, Battaglia acknowledges the supply problem that awaits us beyond the hedge of affordability and inventory build up, but is hopeful that low interest rates will spurn developer activity, keeping prices from rising again.

"When buying activity does start to pick up a little more meaningfully, we do thing that the inventory that’s been building up will start to deplete, and that’s where we get into a situation where that market tightness could reemerge," says Battaglia. But she also reminds us that there's around four months of inventory on the market that will take a while to be eaten up.

However, the low rates that will encourage buyers to hop off the sidelines are the same low rates that will incentive developers to meet demand, she explains. "There’s early signs that a big wave of completions could be coming to an end or at least stabilizing in Toronto, but we do know that as rates come down more developers will probably have a little more appetite to build those new units," says Battaglia. "We do know that across municipalities, provincial governments, the federal government everybody is on board to address the supply crunch, and so there have been a lot of measures put forward to boost that supply. It will take a couple of years to actually materialize into completions, but that should help mitigate some of the tightness moving forward."