Why you should care that the Bank of Canada raised rates
As expected, the Bank of Canada has raised the overnight rate to 1.50%. This is significant because the overnight rate has risen 300% since beginning of 2016 when it was only 0.5%.
In this article, we explain the impact of this trend on mortgage payments and home prices.
The Bank of Canada Overnight Rate
If we look past the 2008 financial crisis, we can see that the “normal range” for the bank rate was 2% to 6%. The financial crisis changed all that, and in a successful effort to protect the Canadian economy from a severe recession, the Bank of Canada dropped rates to 0.25%.
In 2015, the bank was about to raise rates again but then low oil prices hit Alberta’s economy and rates were again pushed down to 0.5%. In the big picture, the bank has stated that they would like to see the rate rise to between 2.5% and 3.5% which they consider the range for a “neutral rate”. That means rates could realistically rise as much as 2% in the next few years. Most forecasts, predict another the rate to reach 2% within 18 months.
A rising Bank of Canada rate means that mortgage rates may be 2% higher by 2020. A homebuyer in 2016 could qualify for a mortgage at a rate of 2.5%, but if expected rises occur they would need to qualify for a mortgage using a rate of 6.5%!
The impact of this change is profound. Let’s compare a household buying a home in 2016 to one facing a higher interest rate future.
What does this do for a homebuyer’s budget?
The example below shows the homebuying budget for a household with a gross income of $100,000 and $200,000 in savings at the different qualifying rates. We assume they are buying an existing condo instead of a pre-sale condo apartment to save them the 5% GST on new construction.
So, by the end of 2020, a family making $100,000 with $200,000 saved up will only be able to afford an apartment at $580,000. Currently the benchmark condo price in Greater Vancouver is $704,200.
A 1% increase in interest rates reduces homebuying budgets by approximately 8%. As interest rates continue to normalize, homebuyers will be able afford less every year, leading to continued downward pressure on home prices. This is already having an impact on the prices of detached homes and it is reasonable to expect the same will happen to condo apartments as willing homebuyers are confronted by the affordability ceiling.
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