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If rates only rise by 1 percentage point by the end of 2016 (while incomes are still assumed to rise by 3 per cent)? Affordability would level off, and there could be room for home prices to grow.. (Fred Lum/Fred Lum/The Globe and Mail)
If rates only rise by 1 percentage point by the end of 2016 (while incomes are still assumed to rise by 3 per cent)? Affordability would level off, and there could be room for home prices to grow.. (Fred Lum/Fred Lum/The Globe and Mail)

How will rising mortgage rates affect Canadian house prices? Add to ...

The Globe’s new Real Estate Beat offers news and analysis on the Canadian housing market from real estate reporter, Tara Perkins, and others. Read more on The Globe’s housing page and follow Tara on Twitter @TaraPerkins.

A 2 percentage point increase in mortgage rates would likely cause a significant price correction in the Canadian housing market if it happened all at once, but not if it took place gradually between now and the end of 2016, says Bank of Montreal economist Robert Kavcic.

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He took a look at what would happen to mortgage payments as a percentage of household income in different scenarios. (He based his calculations on mortgages with 25-year amortizations at average rates for an average priced home, with a down payment equal to half of annual income).

What he found is that an overnight jump in mortgage rates of 2 percentage points would spell trouble. Affordability would be stretched to a degree that “you’d have to see a correction in home prices,” he says.

But if the same rise occurs over the next 19 months while household incomes rise by 3 per cent, then house prices don’t necessarily have to come down, he says. Affordability would be worse, no doubt, but it would stay within a standard deviation of normal levels.

“The point of that particular example is that if that 2 percentage point increase in mortgage rates comes gradually over the course of a couple of years, there probably will be enough income growth to offset it and not necessarily force a correction in home prices,” Mr. Kavcic says.

And what if rates only rise by 1 percentage point by the end of 2016 (while incomes are still assumed to rise by 3 per cent)? Affordability would level off, and there could be room for home prices to grow.

“It’s going to be a much softer environment for the next couple of years than we’ve been used to, but (assuming rates don’t jump at once) not the kind of correction that a lot of people are expecting,” he says.

Most economists are expecting a gradual increase in fixed mortgage rates over the next two years. The rates tend to follow movements in five-year government bonds, because those have an impact on how much it costs banks to obtain the money that they lend out for mortgages.



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