By Niels Veldhuis
and Josef Filipowicz
The Fraser Institute
Despite recent measures by British Columbia and Ontario provincial governments, house prices remain high in Canada’s most desirable markets. In fact, after a brief pause during the latter half of 2016, Vancouver home prices are again on an upward trend.
Attempts to explain high and rising prices often point to “speculation” or demand from abroad, while ignoring other important factors. Those include municipal red tape restricting the housing supply and excessive fees on homebuilders that are passed along to homebuyers in the form of higher prices (these fees average $78,000 per unit built in Vancouver and more than $46,000 in Toronto).
A recent study points to yet another powerful, if often ignored, driver of home prices – falling interest rates.
Real mortgage interest rates have fallen precipitously since 2000, even with a small rate increase made recently by the Bank of Canada. In 2000, typical mortgages were obtained at an interest rate of 7.0 per cent. Last year, they averaged 2.7 per cent, almost two-thirds lower.
What has this meant for the purchasing power of Canadians?
Interest rate declines reduce the amount of income borrowers must spend on interest payments, giving them greater capacity to borrow with the same amount of income. Consider that the average Canadian family income was $50,785 in 2000 (including couples and singles). With mortgage rates at 7.0 per cent, the maximum mortgage amount this family could secure was $180,949. At 2016 rates (2.7 per cent), the same family could borrow $276,610, an increase of 53 per cent.
And this significant boost to mortgage-borrowing power doesn’t account for rising incomes. Indeed, average total incomes for Canadians families grew by 53 per cent from 2000 to 2014 (the latest year of available data).
When combined, falling interest rates and growing incomes vastly increase the amount of mortgage debt that homebuyers can secure. Accordingly, the maximum mortgage for the average family in 2000 ($180,949) grew by 126 per cent to $409,078 in 2014.
The numbers vary across Canada. Consider Canada’s four largest metropolitan areas: Vancouver, Calgary, Toronto and Montreal.
In Calgary, where income growth has traditionally been strong, maximum mortgages secured by average family incomes jumped from $230,706 in 2000 to $602,700 in 2014, a 161 per cent increase.
For average families in Vancouver, maximum mortgages grew 118 per cent (from $183,751 to $392,553) over this period.
In Montreal, they grew 115 per cent (from $171,692 to $369,188).
Even in Toronto, where income growth has been slower, the maximum mortgages that average family incomes can secure have doubled from $221,214 to $441,846.
Again, while lower interest rates present a number of opportunities for potential homebuyers (including smaller portions of mortgage payments being dedicated to interest), low rates can also qualify buyers for larger loans. As such, increased purchasing power ultimately affects home prices.
The extent that this and other variables, including municipal land-use policies, impact prices deserves much closer consideration by Canadians and policy-makers before simply pointing to speculators or foreign buyers.
Niels Veldhuis is president and Josef Filipowicz is a policy analyst at the Fraser Institute. The study Interest Rates and Mortgage Borrowing Power in Canada is available at fraserinstitute.org.
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