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Nadine K. Mohammed and her husband Gordon Brown are seen near their Etobicoke, Ont. home on Thursday Dec. 27, 2012.Tim Fraser/The Globe and Mail

Home prices have doubled over the last decade, propelled by low rates and easy mortgage terms. But as the U.S. experience proved, soaring property values can come with an ugly downside. The Globe and Mail examines the foundation of Canada's historic real estate boom in a series.

Canadian homes have rarely been as expensive as they are now.

For just the second time in the past century, the country's housing market is pushing the limits of affordability, according to key statistical measures, shutting many potential buyers out of the market, and making it harder for those who have already taken the plunge to pay off their mortgages.

In the past decade-and-a-half, house prices have accelerated at a rate that has outpaced increases in disposable income – though interest rates at historically low levels and a greater comfort level with debt helped mask the risks. Even the recent cooling in the housing market has so far been marked by a drop in the number of sales, with little downward movement in prices.

"There is no question that in Canada, we are in a real affordability crisis right now," said John Andrew, a professor in Queen's University's school of urban and regional planning.

Since 2000, the price of houses across Canada has risen 127 per cent; nearly 50 per cent since 2006.

It's no surprise that housing is expensive, but there's no relief in sight. If anything, housing is likely to become even less affordable later this decade as interest rates return to more normal levels – unless there is a precipitous decline in real estate prices.

A sharp spike in rates – like those seen in 1981 and 1990 – is unlikely. But even a small increase in rates will cause major pain for current homeowners saddled with record mortgage debt, larding on hundreds of dollars to monthly payments.

"There is going to be a very rude shock to the system once mortgage rates move up," said Prof. Andrew. "Rates have been low for enough years that people have forgotten how unaffordable houses really are."

A perfect storm

The current run-up in house prices began in about 1997 and has continued almost unabated despite very small gains in income over the same period. Only once before in the last 100 years has there been a similar long-term shift, and that was back during the postwar years as returning veterans and a widespread housing shortage pushed prices up sharply in the late 1940s and early 1950s.

Before that, prices had been very stable in the 1920s and 1930s. And from the 1950s to the late 1990s there was another long period of relative stability, punctuated only by a couple of brief mini-booms in the 1970s and 1980s that were followed by quick pull-backs in prices.

This time, a perfect storm of low interest rates, coupled with a relatively strong economy and Canadians' ever-growing willingness to pile on debt, prompted a nearly unprecedented run-up in prices. High immigration numbers and limited land for expansion in the country's largest cities have exacerbated the problem.

High-school math teacher Nadine K. Mohammed, 32, always thought she'd own a house by now. "I thought I'd go to university, get a really good job, save some money, and that would be the ticket to being able to afford a home. I was so excited," she said.

Instead, the Toronto resident, who has been teaching for eight years, is renting the main floor of a bungalow in the west-end neighbourhood of Etobicoke with her husband. They save everything they can to put toward a down payment and hope to purchase a home in the next two to three years. "But if prices continue to go up, I don't know if that's going to happen," Ms. Mohammed said. "It's kind of a scary thought."

The couple also worries that when they're ready to buy a home in the city, it will be "really tiny."

"As I've gotten older, I've realized I need to adjust my expectations and be more realistic," Ms. Mohammed added.

While some of her friends managed to purchase their first homes when they were in their twenties, they were able to live rent-free with their parents to save money. "Then voila, they had down payments," she said. "Once you have to pay rent, saving takes a lot longer."

Because she knows mortgage rates will likely be higher by the time she and her husband buy a home, Ms. Mohammed figures they will take longer to pay off their mortgage than their friends who already own homes.

'House poor'

Right now, just getting into the housing market is a huge challenge for many Canadians.

The average home in Canada now costs about $350,000, roughly five times the average household income. In the mid-1970s, it was three times average income, says University of British Columbia professor Paul Kershaw, who crunched the numbers for a recent report on generational income gaps.

There are many ways to judge how affordable a house is, but on that most basic measure – how many years of earnings it takes to buy a typical home – houses in Canada are dramatically more expensive than they were four or five decades ago.

Building up enough cash for a down payment can be crippling for many people, Prof. Kershaw says.

"Take an average 25– to 34-year-old in 1976, working full-time and making the average wage. That person had to save for five years to build up a 20-per-cent down payment for an average home," he said. "Today, take the same 25– to 34-year-old. Now, they have to save for 10 years. And in B.C., it is 15 years."

The underlying reason for this, Prof. Kershaw points out, is that housing prices have risen dramatically, while household incomes – adjusted for inflation – have barely moved at all since the mid-1970s.

In 2012, "home ownership is so much more challenging," he said. "And in urban settings, the home you are purchasing, as a younger person, is far less likely to have a yard. And if it does have a yard, it is because you are tolerating a far longer commute."

There are huge social implications in this shift, Prof. Kershaw argues. Young people are becoming resentful of those already in the housing market, and are subject to significant financial stress. Buying a house is getting out of reach, he said, even though it is "a central part of the transition into adulthood."

Two decades ago, one in five Canadians bought homes with less than 25-per-cent down, the amount needed to avoid paying for mortgage insurance. Today, three-quarters of home buyers require insurance from Canada Mortgage and Housing Corp., though the government has lowered the threshold to 20 per cent.

Royal Bank of Canada's respected Housing Affordability Measure underlines the impact of interest rates on housing costs. The index, which tracks the proportion of pre-tax household income required to pay principal and interest on a mortgage, along with property taxes and utilities, shows a huge spike in the early 1980s and again in the early 1990s, when interest rates jumped dramatically.

Significantly, however, the RBC chart also shows that ownership costs have tracked upward pretty much non-stop for the past decade, even as interest rates declined to the current rock-bottom levels.

In the Vancouver market, houses are far less affordable now than they were even during those earlier interest-rate spikes, the Royal Bank's figures show. The current ownership cost of an average two-storey house eats up close to 80 per cent of average household income. Elsewhere in the country, the average is closer to 50 per cent.

A health-care worker in southwestern Ontario who didn't want his name used, said mortgage and child support payments make up roughly half of his take-home income, and that leaves very little for long-term investments such as RESP plans for his kids' education, or retirement savings. "Any forward planning is really limited," he said. "When you are living this way it feels precarious, and that is with a great mortgage rate."

The big worry, he said, is what will happen if rates rise and his payments increase significantly. That could require a drastic lifestyle change such as renting out his basement or selling the house and renting. "That weighs heavily on me," he said.

Prof. Andrew of Queen's said that for many years the generally accepted idea was that housing costs should eat up about one-third of household income. The RBC figures show that the reality today is far different. A range of 40 to 45 per cent is likely a sustainable number over the longer term, Prof. Andrew said, although even at that level "it means that people are not going to have the disposable income to spend on other things, and that is not good for the economy. You want people to be able to spend on cars and trips and those kind of things, without necessarily borrowing against the value of their homes."

He also noted that people's attitudes have shifted significantly, and Canadians are far more willing to accept the fact that they will be "house poor" over the long term. Indeed, that appears to have been the motivation for federal Finance Minister Jim Flaherty to tighten up mortgage lending rules this summer, to try to reduce levels of debt associated with home ownership.

The danger in debt

Canadians weren't always so willing to pile on debt.

Brian and Dency Sharkey became homeowners when they were in their twenties in the mid-1960s, but they were very cautious in buying a house that from today's perspective looks unbelievably affordable.

The couple paid $19,500 for their bungalow in the Ottawa suburb of Nepean, and their monthly mortgage payments amounted to $99. In fact, that was even less than the $115 they had been paying to rent a two-bedroom apartment.

Still, even with two teachers' salaries adding up to about $6,000 a year, it was hard to meet the payments, Mr. Sharkey said. It was done through scrimping, not through further borrowing. "My wife keeps reminding me about drinking powdered milk and that kind of stuff," he said.

Things are different in 2012, and with so many people willing to take on large mortgages and burdensome monthly payments, the big risk is a spike in mortgage rates, or even a moderate rise. A significant number of mortgage loan defaults among homeowners could have a devastating effect on the economy.

Essentially, low interest rates are magnifying the already considerable risks that first-time home-buyers are taking on when buying expensive properties, said Ben Rabidoux, an analyst with research firm M. Hanson Advisors.

"Having young Canadians jump into home ownership, with mortgages that are at income multiples we've never seen before, is exposing a broad section of the population to significant risk if we run into any sort of a recession or macro shock or interest-rate rise," he said. "We are just staggeringly comfortable with debt here in Canada right now."

Exacerbating this issue, Mr. Rabidoux said, is that many young Canadians already have significant debts even before they take on a mortgage. They may owe money on credit cards, and many will still have student debts outstanding when they buy a house. "Twenty or 30 years ago that was not the case."

With house prices now softening slightly in some markets, it is possible affordability will improve over the next few months, Mr. Rabidoux said. That would be healthy in the long term, and may eventually bring in new buyers who have been priced out of the market. But in the short term, our economy is so tied to the housing boom, and the construction jobs it generates, that a weakening housing market is "backing policy-makers into a corner," he said. Politicians would like to see house prices decline to make them more affordable, yet they worry that any decline in home-building could dent an already weak economy.

With files from Claire Neary


The payment pinch

A look at how mortgage payments could change if rates go up:

$350,000 mortgage

$1,656.36: Monthly payments for a 25-year mortgage at a 3-per-cent rate

$480: The increase in monthly payments at 5.5 per cent

$795: The increase in monthly payments at 7 per cent.

$500,000 mortgage

$2,366.23: Monthly payments for a 25-year mortgage at a 3-per-cent rate.

$686: The increase in monthly payments at 5.5 per cent.

$1,136: The increase in monthly payments at 7 per cent.

Source: CanEquity

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