Falling interest rates—an often-overlooked contributor to rising home prices

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Appeared in the Vancouver Province, August 17, 2017

Despite recent measures taken by provincial governments in British Columbia and Ontario, house prices remain high in Canada’s most desirable markets. In fact, after a brief pause during the latter half of 2016, Vancouver home prices are once more on an upward trend.

Attempts to explain high and rising prices often point to “speculation” or demand from abroad, while ignoring other important factors including municipal red tape restricting the housing supply, or excessive fees on homebuilders that are passed along to homebuyers in the form of higher prices (these fees average $78,000 per unit built in Vancouver and more than $46,000 in Toronto).

A recent study points to yet another powerful, if often ignored, driver of home prices—falling interest rates.

Despite the recent, small interest rate increase by the Bank of Canada, real mortgage interest rates have fallen precipitously since 2000. In 2000, typical mortgages were obtained at an interest rate of 7 per cent. Last year, they averaged 2.7 per cent—almost two-thirds lower.

What has this meant for the purchasing power of Canadians?

Interest rate declines reduce the amount of income borrowers must spend on interest payments, which gives them greater capacity to borrow with the same amount of income. Consider that the average Canadian family income was $50,785 in 2000 (including couples and singles). With mortgage rates at 7.0 per cent, the maximum mortgage amount this family could secure was $180,949. At 2016 rates (2.7 per cent), the same family could borrow $276,610, an increase of 53 per cent.

And this significant boost to mortgage-borrowing power does not account for rising incomes. Indeed, average total incomes for Canadians families as a whole grew by 53 per cent from 2000 to 2014 (the latest year of available data).

When combined, falling interest rates and growing incomes vastly increase the amount of mortgage debt homebuyers can secure. Accordingly, the maximum mortgage for the average family in 2000 ($180,949) grew by 126 per cent to $409,078 in 2014.

The numbers vary across Canada. Consider Canada’s four largest metropolitan areas: Vancouver, Calgary, Toronto and Montreal.

In Calgary, where income growth has traditionally been strong, maximum mortgages secured by average family incomes jumped from $230,706 in 2000 to $602,700 in 2014, a 161 per cent increase. For average families in Vancouver, maximum mortgages grew 118 per cent (from $183,751 to $392,553) over this same period, and in Montreal they grew 115 per cent (from $171,692 to $369,188). Even in Toronto, where income growth has been slower, the maximum mortgages average family incomes can secure have doubled from $221,214 to $441,846.

Again, while lower interest rates present a number of opportunities for potential homebuyers (including smaller portions of mortgage payments being dedicated to interest), low rates can also qualify buyers for larger loans. As such, increased purchasing power ultimately affects home prices. The extent that this and other variables, including municipal land-use policies, impact prices deserves much closer consideration by Canadians and policymakers before simply pointing to “speculators” or foreign buyers.

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