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Rising Interest Rates Main Problem for Housing Market in Canada, say experts

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As Canada’s housing market shows tentative signs of homebuyers’ fatigue, some economists are looking ahead at another factor that’s widely expected to put a damper on the real estate frenzy: rising interest rates, the Global News reported.
New York-based Bloomberg, the global news and data firm, last week ranked Canada as one of the bubbliest housing markets on the planet, while closer to home, a former Bank of Canada economist published research that suggests housing in Toronto and Ottawa is overvalued based on historical metrics, while Montreal is becoming increasingly so.
With economic activity revving up again amid soaring vaccination rates and signs of inflation, several analysts believe the Bank of Canada will start raising its trend-setting interest rate sometime in the second half of 2022.
The question is how rising borrowing costs might affect the housing market, which has grown to account for an outsized share of the country’s $2.4-trillion economy.
“That’s the number one issue facing the Canadian economy: the increased sensitivity to higher interest rates,” says Benjamin Tal, deputy chief economist at CIBC.
With many Canadians shouldering large mortgages, even a small increase in interest rates would have a significant impact on household balance sheets, he warns. An increase of just 1.5 percentage points in interest rates could double the monthly mortgage payment for some homeowners, he says.
“The housing market will probably be the first casualty of higher rates,” St-Arnaud, who previously worked at the Bank of Canada and for Morgan Stanley and Nomura Holdings Inc. in London, said. “When rates go up, that affordability will disappear very, very quickly.”
Bloomberg’s “Bubble Ranking” generates country scores by considering what it costs to buy a home compared with renting; the price-to-income ratio; inflation-adjusted price growth; nominal price growth; and the annual rate of household credit growth. New Zealand sits on top of the list, posting the highest marks in four of the five categories. Canada is second, followed by Sweden, Norway, and the United Kingdom, respectively.
The Bank of Canada has left its key interest rate at an historic low of 0.25 per cent since March 2020, when the central bank quickly slashed borrowing costs to soften the impact of the economic crisis linked to the COVID-19 pandemic.
Higher interest rates are widely expected to provide a welcome breather from breakneck home price growth, Tal says.
“Even a small increase in interest rates would be sufficient to slow down the market — and that would be a very good thing,” he says.
But too much of a good thing could expose heightened vulnerabilities in the Canadian economy, Tal and other economists say.
“If interest costs were to go up one to two percentage points, because of the level of debt, households could be put in a position where they’re devoting a significant share of their income to making their mortgage payments,” says Diana Petramala, senior economist at Ryerson University’s Centre for Urban Research and Land Development.
Canadian households have accumulated $1.96 trillion in debt held through mortgages and home equity lines of credit (HELOCs), with the pace of mortgage borrowing registering a record month-over-month increase in April, according to data from Statistics Canada.
So far, however, rock-bottom interest rates and higher incomes are helping Canadians manage their debt. Even as mortgage debt soared, overall debt loads as a share of household disposable incomes are lower than in pre-pandemic times.
As of the first three months of 2021, Canadians owed $1.72 in credit market debt for every dollar of disposable income. That compares with $1.81 dollars in debt for every dollar of disposable income at the end of 2019.
And as Canadians piled on mortgage debt, they have also been paying off more expensive kinds of debt. Canadian households’ collective credit card debt, for example, dropped from nearly $90 billion in December 2019 to $74 billion in April 2021, Statistics Canada data shows.
But as borrowing costs rise, debt-to-income ratios will likely climb as well, Petramala says. And higher interest rates may not only force homeowners to use more of their income on mortgage payments, they will also make it harder to pay off mortgage debt, with a larger share of payments going toward interest charges instead of the principal, Petramala notes.
One potential risk, says Tal, is that rising inflation will force the Bank of Canada to accelerate the pace of interest rate increases.
The latest inflation readings seem high in part because they are a comparison with the spring of 2020, which saw a steep decline in prices. A number of supply shortages and logistical logjams tied to the pandemic have also resulted in price spikes for materials like lumber, goods like furniture, and parts like the microchips used in many consumer electronics as well as cars and trucks.
While many of the factors pushing up prices are temporary, it’s unclear how long the inflationary pressures will last, Tal says.

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