Rising interest rates in the news are impacting everything from food and energy to housing and services. In this article, we will focus on drawing connections between different political events that have brought us here and discuss where we may be headed with continuing rate increases caused by inflationary pressures. We will also discuss how this impacts a homeowner’s bottom line – if you’re coming up for renewal, refinance, or ready to purchase.

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Key Highlights

• House prices are sliding, but due to the BoC rate increase, we are also seeing home sales drop month over month.
• BoC wants to tame inflation, but many other economic pressures are not making their job easy for them.
• Central bankers don’t want to replicate the double recession that took place in the 1970s, resurging until the early 1980s.
• For every $100K balance with each 25 basis points (equal to 0.25%) increase equals to an increase of $14 monthly on your mortgage payment and would require an additional qualifying income of $500 per year.

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Housing Prices Slide Due to Inflation

Housing prices are sliding, but you are not seeing borrowers racing to buy. The Canadian Real Estate Association (CREA) is reporting month-over-month home sale declines. Just a few months ago we were sitting in a sellers market which wouldn’t even allow anyone to have conditions attached to their purchase. Of course, we all know the main culprit is the interest rate increases from the Bank of Canada (BoC). 

How long will the rate hikes last? Truly no one knows exactly how long it will last. The Bank of Canada (BoC) has a single goal to reach before easing up on rate increases. Their goal is not to hit a specific rate before reversing course. Rather it is to bring inflation below 2% again – or they may reverse course when they know that their goal is in sight. The BoC’s job is to control the inflationary pressure on the lives of Canadians and increasing rates is a tool that they use most often to curb it. 

The real problem is that the BoC has no control over 65% of inflation. They can certainly slow it down by increasing the country’s main key borrowing rate but this only controls about 35 to 40% of inflation – the rest is controlled by supply chain trends from outside our borders.  In addition to this slow down in the supply chain, which in turn creates more demand, there are other forces in play that are going unchecked, such as unemployment, wages, demand for workers, but mainly consumption.

Interest Rate Increases Not Curbing Inflation Fast Enough

Typically, increasing rates is supposed to slow down economic activity in the country by creating a lack of demand, thus making it more expensive to buy houses, goods, staples, resources and also costs to hire labour. But even if you look at the headlines, you can see that Canada is still adding net new jobs to the economy as our unemployment rate decreases once again in September. This is not the news that BoC needs to hear to reverse course on rate hikes anytime soon. Pressure on resources and demand for goods has not slowed either, making the case for another 50 or 75bps (meaning 0.50% or 0.75%) warranted along the 300bps increase path that the central bank has already laid out so far.

The BoC’s own latest forecast that was published in July sees inflation averaging 4.6% next year and not returning to the Bank’s target 2% until some time at the end of 2024. Private-sector industry experts and financial markets are forecasting a 50bps increase. The main question for borrowers and investors is how much further can the BoC raise interest rates? Analysts are forecasting that the central bank will propel its policy rate just above 4% before plunging it.

Inflation volatility illustrated through changes in the Canadian Consumer Price Index (CPI) for year-over-year (Fig.1 on the left) and month-over-month (Fig.2 on the right) fluctuations for the last three years.

Even though we have seen incremental increases in unemployment, average wages are still rising as employees demand more wages to account for inflation. This issue is becoming endemic with inflation and creating a Catch-22 loop which we can’t exit fast enough. The labour market is currently quite tight, requiring higher labour costs as well as wage increases to attract new workers. Businesses will have to pass this on to the consumer – adding further to inflationary pressures. As workers make more money, they will be able to pay more for goods and services.

Central Bankers Worried About Repeating A Double Recession

Your mom and dad may tell you that today’s rates are nothing compared to what they paid in the late 1970s or early 1980s. Yes indeed, they may have paid 18% interest in the early 80s albeit their houses were not even priced $100K on average.  And yes they may have only had an average income of $20K annually, but then again that was a fifth of their home price.  Now our average income might be closer to $100K but our home prices are closer to $1M which makes it twice as hard to carry a mortgage on a comparable income. Add to this a shorter mortgage amortization – only 25-years allowed versus their 40-years. A down payment was not required and certainly no mortgages were stress tested as they are now.  Is it any wonder that the home ownership rates have been dropping year over year?

The 1970s were an interesting time to be alive. In fact, the decade saw some of the most stunning economic growth and policy shifts in history. There was high inflation that wouldn’t just soar but also came down before rising again with renewed force at various points throughout this period! And while we may remember these years for their consistently tight monetary policies from both the Federal Reserve (the Fed in the US) or Bank Of Canada (the BoC) – the reality is more nuanced than you might think.

Central bankers of the 1970s had a single overwhelming takeaway from that decade – don’t ease up on fighting inflation until you’re certain it has been defeated. When the Fed and the BoC cut their policy rates in 1976, they thought that inflation had hit its peak. However, when this turned out to be untrue by the decade’s end with prices rising at an increasingly faster rate than before, both institutions were forced into raising rates high enough so as to prevent any more damage from being done.

Where the Fed and BoC are cautiously drawing conclusions: The 1970s showed inflation (illustrated below with the Canadian Consumer Price Index) can be volatile and persistent. Proclaiming success too soon on inflation after a temporary reprieve can result in an even bigger spike later. Canadian CPI for year-over-year (Fig.1 on the left) and month-over-month (Fig.2 on the right) fluctuations from January 1970 to December 1985.

The handbook on modern day inflation was pretty much written in the 1970s and even now influences the choices that central bankers make. The US economy is the main driver of economic growth for Canada and much of the developed world. For this reason, the Fed is taking a very cautious approach to easing up on rate increases as they patiently wait for inflation to calm down. Aside from a lower trending GDP growth, lagging indicators of inflation such as unemployment, trade balance, consumer price index, corporate profits and labour costs have not seen much of a dent.

Lack of Labour and Material Supply Also Fuelling Inflation

Labour and imported materials to build homes has gone up quite a bit in the last 40 years.  Canada is no longer home to 20 million people but rather closer to double that number. Since those days, we have proven that immigration is a source of economic growth and stability for the country, bringing in easily 1M more immigrants to Canada each year. There is a looming question on how Canada plans to house these new entrants to the country, as housing affordability becomes an endemic problem affecting generations of Canadians.  

It’s not that we don’t have space to build new homes or that we lack materials, but rather the labour to build them. We need skilled trade workers as well as policies to decrease red tape on zoning and building permits for builders. This shortage of labour is only one of the issues that we have to tackle before we see a resolution. Another is supply chain as energy costs increase due to the war on Ukraine which placed sanctions on Russian petroleum and natural gas. Known as the breadbasket of the world, Ukraine produces almost half the whole grains and oils consumed by the world. These factors are affecting consumers as more of a household’s take home income is disproportionately going towards grocery and staples which is making home affordability suffer further.

Housing Supply Shortages Set Dismal Expectation for Affordability in the Future

Canadian Mortgage Housing Corporation (CMHC), a crown corporation set up by the federal government to make it easier for Canadians to own and mortgage their homes, forecasts that the biggest provinces in Canada by population (ON, QC, BC and AB) will only be able to increase housing starts by 30 to 50% over the next 8 years. This creates acute challenges and falls well below the required number of homes needed to address the shortage. As a remedy, CMHC suggests building apartments and condos, where labour costs are limited to one building making it easier to move workers and equipment around – versus a subdivision with many buildings being built simultaneously.

Internationally, China’s markets have stalled as some of their biggest real-estate developers defaulted on their loans. Their banking crisis and resurgence of COVID is slowing down overall capacity. Our biggest trading partner, the United States, is seeing its own set of problems with inflation. The US currently has higher inflationary pressures than Canada but they are taking a more cautious approach than we are up North. The runaway inflation there is driving the US dollar on a divergent course away from other developed economies’ currencies, including the Canadian dollar.

Although the US measures unemployment differently than Canada, the overall picture is showing that they are having their own set of pressures. Unemployment rates have dropped slightly to 3.5% due to a tight labour market with almost 400K women leaving the labour force. The employment report suggests that the economy was not in a recession despite the GDP contracting in the first half of 2022. Risk of a downturn next year is mounting as the Federal Reserve (the Fed) stays on its aggressive monetary policy tightening campaign to fight inflation.

How Do Rate Increases Affect Your Mortgage Payment and Qualifying Income

It is for these reasons that would make me suggest that higher and increasing prime rates are here to stay for the shorter term – hopefully no longer than the end of 2024. So what does that mean for the average person, well it just means that you have to plan for the worst case scenario by budgeting a little bit extra. Simplifying in terms of mortgages and accounting for some over-reaching assumptions this means you’ll need to make $3400 more annually to qualify for each 25bps (that is 0.25%) increase for each $100K mortgage balance that you carry. Albeit, your true mortgage payment will only be impacted by a $14 increase in monthly payment terms. 

Below are some charts to help you conceptualize mortgage payments and qualifying income for each $100K balance with each 25 bps increase.

Mortgage Balance at 4.20%	Mortgage Payment	Qualifying Income
100000	536.92	40,060.11
200000	1,073.84	62,405.83
300000	1,610.76	84,751.54
400000	2,147.68	107,097.26
500000	2,684.60	129,442.97
600000	3,221.52	151,788.69
700000	3,758.44	174,134.40
800000	4,295.36	196,480.11
900000	4,832.28	218,825.83
1000000	5,369.20	241,171.54

Mortgage Balance at 4.45%	Mortgage Payment	Qualifying Income
100000	550.70	40,576.11
200000	1,101.40	63,437.83
300000	1,652.10	86,299.54
400000	2,202.80	109,161.26
500000	2,753.50	132,022.97
600000	3,304.20	154,884.69
700000	3,854.90	177,746.40
800000	4,405.60	200,608.11
900000	4,956.30	223,469.83
1000000	5,507.00	246,331.54

Mortgage Balance at 4.70%	Mortgage Payment	Qualifying Income
100000	564.65	41,097.26
200000	1,129.30	64,480.11
300000	1,693.95	87,862.97
400000	2,258.60	111,245.83
500000	2,823.25	134,628.69
600000	3,387.90	158,011.54
700000	3,952.55	181,394.40
800000	4,517.20	204,777.26
900000	5,081.85	228,160.11
1000000	5,646.50	251,542.97

Mortgage Balance at 4.95%	Mortgage Payment	Qualifying Income
100000	578.77	41,623.20
200000	1,157.54	65,532.00
300000	1,736.31	89,440.80
400000	2,315.08	113,349.60
500000	2,893.85	137,258.40
600000	3,472.62	161,167.20
700000	4,051.39	185,076.00
800000	4,630.16	208,984.80
900000	5,208.93	232,893.60
1000000	5,787.70	256,802.40

Mortgage Balance at 5.20%	Mortgage Payment	Qualifying Income
100000	593.05	42,153.60
200000	1,186.10	66,592.80
300000	1,779.15	91,032.00
400000	2,372.20	115,471.20
500000	2,965.25	139,910.40
600000	3,558.30	164,349.60
700000	4,151.35	188,788.80
800000	4,744.40	213,228.00
900000	5,337.45	237,667.20
1000000	5,930.50	262,106.40

 In the worst case scenario of a 100bps increase, a client carrying $100K balance would need an income boost of $2100 annual to qualify; and for a $1M balance an increase in income of $16K would be needed.

What Options Do You Have to Mitigate Inflation

So what can you do here? First, look at what all your options are: can you afford to carry a larger payment? Are you planning on keeping the home for a longer term? What is the cost assessment to rent versus homeownership? Do you expect to save money if you delay your purchase? Let’s look at these questions one at a time.

Early Renew Your Mortgage to Lock in Your Rate

If you can afford to carry a larger payment but prefer to have your sanity back, you could have the ability to early renew your variable rate to a fixed rate and lock in the payment for the next 3 or 5 years. Overall the rate may be lower than the current variable rates but there is a chance that if the longer term outlook is better than the shorter term outlook then variable rates may overtake fixed ones before inflation is tamed. If you have already purchased but qualified on a variable rate then review with the lender to see if you can move forward with a fixed rate. Or, if qualifying is the issue, you have the option to early renew to a fixed rate almost immediately after your closing – once your mortgage is funded.

Extending Your Mortgage Term to Hedge Inflation

If you are planning on keeping your home for a longer term – not expecting transfers to another province or country – then perhaps you can renew to a longer term mortgage to avoid the possibility that you would have to renew again in a few years and rates have not come down yet. If you’re mulling over fixed and variable for your purchase – at the end of the day it’s all about personal preference and risk. If you are in a true variable mortgage (rates move up but payment stays static) you may need to make a prepayment within your term to keep it from hitting your trigger point; or consider going with an adjustable mortgage or a shorter term fixed rate – both of which have the probability of a higher payment than variable – but will save you a hassle compared to a true variable mortgage.

Renting While You Wait for Inflation to Settle Down

You can also compare the costs of renting versus ownership. Assuming that average rent for a 1-bedroom apartment is $2000 across the country then you’re looking at $24,000 in annual rent. Will $24K cover your annual mortgage payments – probably not – but then again you won’t build equity by renting. Once the inflationary pressure settles, homes will start rising again so then you may have to translate any savings into a premium added to the increased cost to purchase your home. Whereas, higher rates may not last as long as it takes to build up savings for a downpayment – so if you’re in a place where you can buy now or in the next 3 months then I would recommend locking in a rate and waiting for the perfect home.

Delaying your purchase to avoid higher rates and possibly buying for a lower value may sound like a good idea. And perhaps this can definitely help you save money but only if you get the timing right. If you get it wrong then the market will quickly revert back to a sellers market. What are the benefits of buying now? The biggest benefit is that it is a buyers market for the first time in a decade. You don’t have to give up anything. You can still place conditions and do your due diligence before you buy one of the biggest investments of your lifetime. Previously you’d have had to waive your conditions, be in bidding wars and maybe even write a love letter to the seller before they even looked at your offer. Now you can do whatever it takes to make sure you’re perfectly happy with your purchase. In this market, I have even heard of people putting a conditional purchase on 90-days to complete a firm sale of their home. Prior to 2022 this was almost unheard of unless you were an insider in the transaction or knew the seller well.

Home Prices Won’t Stay Low for Too Long

Icing on the cake. Regardless if you are renting or buying – or delaying your purchase, these are the facts. Prices must always go up – our economy depends on it. Our economy is based on consumption and supply-demand constrictions. Demand is there and will only increase as another 1 to 2 million immigrants make Canada home each year – the vast majority settle in Ontario and BC where homes are already priced the highest. 

As global warming escalates over the next couple of decades more and more people will relocate to Canada as climate refugees. There are only two countries with large boreal forests in the world to slow land erosion – Canada and Russia. Canada also has a third of the world’s freshwater supply and political stability which makes it the best host country for most climate refugees. These are not refugees escaping a war but rather people relocating.  These are people with money and skills to add to Canada’s economic growth making housing a sought after commodity – further exacerbating the acute problem of home affordability.

Final Thoughts

Your home is a tangible asset with long term appreciation – making the last 6 months (or even the next couple of years) a blip in the general direction of home prices.  So, should you buy a home today? Absolutely! Should you wait for the perfect time? Definitely not. The market is always changing and there’s no one right answer for everyone. Instead, rely on your goals – both short and long term – to help guide your decision-making process when it comes to buying a home. Remember, your home is an investment that will appreciate over time so make sure you purchase at a time that works best for you and your family.

Our current market conditions may be less than desirable, but that doesn’t mean that home prices won’t rebound in the future. So, if you are on the fence about whether or not to buy, remember that now is always better than later! If you are thinking of buying in Canada in the next few years (or now!) – get in touch with one of our knowledgeable mortgage experts who can help guide you through every step of this important life decision.

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