How does the Bank of Canada interest rate affect your hunt for a first home, or your mortgage?

Why interest rates matter

The Bank is in a fight against inflation. The consumer price index sat at 3.4% in May, well above the Bank’s target of 2%. This fight is going on south of the border as well, where the U.S. Federal Reserve held interest rates at 5% - 5.25% — and indicated that more hikes are a strong possibility.

With the Canadian economy closely tied to our southern neighbours, the BoC may need to raise interest rates yet again.

“We need to make sure that there's not too much of a divergence in our interest rate policies, or benchmark rates,” said Adil Dinani, a Vancouver-based real estate agent with Royal LePage West.

“If we don't follow the States, our dollar suffers,” said Tom Storey, a sales representative with Royal LePage Signature Realty in Toronto.

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Link between house prices and interest rates

Dinani sees the Bank of Canada holding interest rates as a positive sign for the housing market.

He notes that, historically, there’s been an inverse relationship between the BoC’s interest rates and home prices. As the Bank rate rises, home prices decline. That seems to be holding true so far.

According to the Canadian Real Estate Association, the benchmark price for a detached home in Vancouver was $1,813,100 in February, a decrease of 12% from the previous year. Meanwhile Toronto saw a decrease of 17.9%, with the medium home price sitting at $1,095,617 in February 2023.

That’s still substantially more than the national average home price of $662,437 — which declined 18.9% from the previous year.

Why haven’t high interest rates lowered prices more substantially in these markets?

“If you look at the active inventory in Toronto,” Storey said, “as of right now, for properties available, it's nowhere close to where it was in 2008.” That year saw listings upward of 25,000, while the active inventory is now closer to 14,000.

Despite higher interest rates slowing the boom, that high demand and lack of supply continues to drive home prices upward, making housing unaffordable in some regions.

In Q4 2022 the housing affordability index showed a slight decline; from slightly over 10%, to just under. Meanwhile, the National Bank of Canada’s Housing Affordability Monitor demonstrates that in Vancouver and Toronto, homes are still not affordable.

In Vancouver, the monthly mortgage payment on median home prices for non-condominiums was 120% of the median income for Q2 2022, while Toronto was at approximately 96%.

And it doesn’t look like Toronto is getting more affordable anytime soon.

The Toronto Regional Real Estate Board (TRREB) anticipates that the average selling price of homes will rise to $1,140,000. This indicates that, despite a 4% dip in price from 2022 as a whole, the Toronto market has high demand.

Buying a home

Storey recognizes that today’s mortgage rates make it more difficult for first-time homebuyers to enter the market.

So, what can you do if you’re looking to buy your first home?

While you may be approved for a substantial mortgage, Storey points out that there’s no reason you have to take the full loan you are offered. If you’re approved for a million-dollar mortgage, it doesn’t mean you need to buy a million-dollar home.

Dinani and Storey both believe it’s critical to audit yourself and your finances before jumping into the housing market.

When it comes to rates, Storey says that most people buying a home anticipate they’ll live there for the next five years.

“If you think that rates are going to hold and then go down next year, then you may consider a variable rate, but you're taking a gamble on it.”

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Renewing your mortgage

If you might sell your home within a year or so, Storey said it’s worth considering a variable-rate mortgage at the time of renewal. Even though variable-rate mortgages presently charge higher rates than fixed-rate ones, Storey points out that the penalties for breaking them are cheaper.

The penalty for breaking a variable-rate mortgage, is often about three months interest, while breaking a fixed-rate mortgage requires you to pay additional fees, such as the prepayment penalty. This is based on how much time is left in your mortgage term, and can amount to thousands of dollars.

Can you pass the stress test?

If you are determined to buy this spring, you shouldn’t let a high (but manageable) mortgage deter you from possibly getting a home. However, you shouldn’t make the commitment if the mortgage payments will lead to financial strain.

The mortgage stress test ensures homebuyers can manage higher interest rates. This test ensures that mortgage holders are able to pay an interest rate of 5.25%, or the buyers’ current rate plus 2%, whichever is higher.

If you're coming up on renewal, chances are that you were stress-tested to 5.25%. With the rise in rates, you'll now be tested around 7%.

Whether you’re looking to purchase your first home, or are in the market to upgrade from your current residence, the key is knowing what you can comfortably afford.

“Look for the best opportunity in the market that will allow you to build equity,” said Dinani, “and eventually graduate to the next level.”