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Until recently, rising home prices were the main affordability issue for buyers. Now, we also have a worsening inflation problem to contend with.Fred Lum/The Globe and Mail

Inflation keeps hitting new 30-year highs and pressure is building for a cycle of interest rate hikes like we haven’t seen in decades.

So, of course, the average national resale house price was up 20.6 per cent in February compared with a year earlier. In dollar terms, the average price increased to $816,720 from $677,435. We’d be close to an average price of $1-million if the year ahead brings another 20-per-cent price increase.

It couldn’t possibly, right?

Rationally speaking, no. All things considered, we might have the worst home-buying conditions since mortgage rates topped 20 per cent back in the early 1980s. But there’s a lot of momentum in housing today as the fear of missing out drives both investors and people who just want to own a home to keep bidding up prices. From the perspective of personal finance and not emotion, this makes no sense.

Until recently, rising prices were the main affordability issue for buyers. Now, we also have a worsening inflation problem to contend with. Statistics Canada reported Wednesday that the cost of living in February was 5.7 per cent higher than a year earlier. In March, 2021, the inflation rate was just 2.2 per cent.

There aren’t any mortgage affordability calculators that factor in rising living costs. But paying more for gas, groceries and other goods makes it harder to afford houses that can be hundreds of thousands of dollars more expensive than 12 months ago.

Listen to this Stress Test episode on how soaring house prices are hurting affordability

Are the variable-rate mortgage fanatics right?

Rising rates are the next hurdle for affordability. The Bank of Canada increased its overnight rate by 0.25 of a percentage point earlier this month and financial markets were lately betting on a cumulative increase this year of 1.25 of a point. The cost of carrying a variable-rate mortgage changes in unison with the Bank of Canada rate.

Fixed-rate mortgage rates have been edging higher in recent months and pressure for more increases is building fast. Five-year fixed rates are influenced by the yield on the five-year Government of Canada bond, which this week crossed the 2-per-cent mark for the first time since late 2018. One year ago, five-year Canada bonds had a rate of 0.99 per cent.

For now, and this could change, financial markets have brushed aside the concern shown just a week or two ago that the war in Ukraine will derail global economic growth. Inflation is a big worry and there’s a sense that central banks will need a firm hand to control it.

The impact of higher rates on affordability is an increase in the number of households that get priced out of the housing market. Take Toronto, which was singled out as the most unaffordable market in the country in a recent report by Charles St-Arnaud, chief economist at Credit Union Central Alberta. Gross family income of $209,000 is needed to afford the average house in the city, according to the report.

If rates go up by 1.5 percentage points and prices stay level, then the family income required for an average home rises to $245,000. If prices go up by 10 per cent as well, family income needs to be $270,000. These calculations assume a 20-per-cent down payment, a 25-year amortization and typical discounted mortgage rates. Three affordability bargains pop up in Mr. St-Arnaud’s data – Calgary, Edmonton and Winnipeg.

Mr. St-Arnaud is among the economists who think rising rates will moderate demand for housing. But he also sees inflation having an effect. “Inflation squeezes the purchasing powers of families,” he said. “Some may have to start thinking that maybe they can no longer afford the big mortgage they were thinking about.”

The resilience of Canadian house prices to economic challenges is legendary. The global economic crisis was a mere annoyance, the pandemic was party time. Now, we have a multidecade high for inflation, and rising rates. The only thing potentially holding back rates is a worsening of the Ukraine crisis, which may present far bigger problems than just an economic slowdown.

Homebuyers must now sort through all of this and decide whether to venture into a clearly overheated market or step back for a while. One way or another, it’s going to be a hell of a spring in the housing market.

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