If you believe the headlines, housing prices are on the rise across Canada even as consumer debt continues to pile up. The allure of low mortgage rates has thousands of home hunters bidding on what appear to be overpriced properties. But is that really the case?
When it comes to understanding the true price of a home, there’s one main factor to keep in mind – affordability. When the affordability of homes good, demand will usually exceed supply, leading to a hot housing market. So, just how affordable are homes in the current market? The answer from the Bank of Canada might surprise you.
What’s Affordability?
Housing affordability is a relatively paradoxical statistic. Consider our current market. Housing prices have nearly doubled in the past 10 years, which would probably lead you to believe in a lack of affordability. But in all actuality, we’re seeing the exact opposite happening across Canada. Since affordability is a debt service ratio, it’s closely linked to how much homeowners can borrow, rather than how much they can actually afford.
With that being said, national affordability is almost the same or better than 20 years ago, according to the Bank of Canada and a handful of major economists. This is due largely in part to falling interest rates. Take discounted mortgage rates, for example. Over the past two decades, discounted mortgage rates have dropped more than five percentage points.
But How Affordable is Affordability, Really?
As counter-intuitive as it might seem, affordability doesn’t measure home prices or total debt. It actually measures how “easy” it is to make the payments. Which is perfect for today’s debt-strapped consumer. Cheap mortgage rates lower the barrier to entry, which increases affordability irregardless of overall cost. In fact, the more affordable the market is, the more expensive a mortgage becomes over time. Low rates lead to large mortgages and large mortgages lead to long, drawn-out interest payments.
The Dark Side of Affordability
Low mortgage rates give borrowers a ton of leverage, which is making the Bank of Canada extremely nervous. The easier it is to obtain financing, the harder it is to manage increased payment requirements when rates go up. When this happens, real estate prices will almost certainly “roll over.” According to a report released by a BMO senior economist, the typical house will no longer be affordable when rates increase. “Prices need to fall when rates rise just to prevent housing from getting more unaffordable.” Economists believe that as little as a 2 percent increase could put enough strain on the system to slow the market completely. To put that into perspective, a greater-than-16-percent fall in national home prices would be required in order to cancel out the affordability damage of a 2 percent rate hike.
How to Get Affordability Under Control
An affordable housing market isn’t necessarily a good thing. As such, regulators are currently planning a new federal lending guidelines in order to manage affordability and ensure realistic measures. Proposals being considered would require banks and federal trust companies to:
- Make borrowers prove they can afford higher rates, even if they have a large down payment
- Discontinue cash-back down payment mortgages (100% financing models)
- Make self-employed borrowers provide more proof of income
- Restrict interest-only lines of secured credit
- Use more conservative debt ratio tests
According to sources at the Globe and Mail, some or even all of these lending guidelines could be finalized as early as the summer of 2012.
While misleading, housing affordability is still an important measure to consider when securing a mortgage pre-approval. Contact a professional mortgage broker to better understand the true costs of your mortgage.