On July 24, the Bank of Canada (BoC) cut its benchmark interest rate for the second time in two months. Combined with declining government bond yields, this move has pushed mortgage rates to their lowest levels in 17 months. While some experts are predicting a boost to the real estate market, a look back at history tells a different story.
WOWA Leads conducted a 50-year analysis of the relationship between mortgage payments and income in Canada, focusing on how home prices have reacted to significant drops in mortgage rates. The findings reveal that the cost of owning a home is still consuming nearly all of the average Canadian’s disposable income, even with lower rates.
Currently, housing markets in Toronto and Vancouver are stagnating, while cities like Montreal, Calgary, and Edmonton are experiencing growth. Toronto regions is seeing a sales-to-new-listing ratio of just 35%-40%, indicating a buyer’s market, with the highest inventory levels since 2010, nearing 25,000 properties.
We’ve seen this level of unaffordability twice before since 1975—in the early 1980s and 1990s. Unaffordabiliy also peaked during the mid-90s, and during the 2007 financial crisis. What happened during those times?
1981-1983: Interest Rates Soar, Prices Plummet
In August 1981, the BoC rate peaked at an astonishing 20.78%. By July 1983, it had fallen to 9.26%. Despite this steep rate cut, home prices dropped by 14%, while inflation surged by 17%.
1990-1994: Another Rate Cut, Another Price Decline
The BoC rate fell from 13.5% to 3.6% during this period, but home prices didn’t rise—instead, they fell by 8% while inflation increased by 10%. The GTA experienced a significant downturn, with home prices dropping 28% from April 1989 to August 1993.
1995-1996: Affordability Peaks Again
While not as severe as earlier periods, unaffordability spiked again in the mid-90s. The BoC rate dropped from 8.2% in March 1995 to 3% in November 1996. Still, home prices declined by 4.5%, and inflation grew by 3%.
2007-2008 Financial Crisis: A Familiar Pattern
In 2007, the housing market faced another period of unaffordability. From Q2 2008 to Q1 2009, home prices dropped by 9%, even as the BoC rate fell from 4.25% to 0.25%. Interestingly, the housing market rebounded quickly after that, with prices rising sharply in 2009.
Why Do Home Prices Drop When Affordability Improves?
One might expect that as mortgage rates fall, home prices would rise due to increased affordability, but history shows a different trend. The lag effect of previous rate hikes, economic slowdowns, and rising unemployment often lead to a decrease in home prices, even as rates fall. This effect is more pronounced in fixed-rate mortgage markets like Canada, where the impact of rate hikes is most felt during mortgage renewals.
When the BoC cuts rates, it’s usually a sign that inflation is falling due to a weakening economy, which often brings higher unemployment and decreased earnings, especially for self-employed individuals. These factors contribute significantly to falling home prices, even if sales are up. However, we may be coming out of the "lag effect" and rebound more quickly as we saw most recently in 2009.
"It was encouraging to see an uptick in July sales relative to last year. We may be starting to see a positive impact from the two Bank of Canada rate cuts announced in June and July. Additionally, the cost of borrowing is anticipated to decline further in the coming months. Expect sales to accelerate as buyers benefit from lower monthly mortgage payments."
-Jennifer Pearce, TRREB President
"As more buyers take advantage of more affordable mortgage payments in the months ahead, they will benefit from the substantial build-up in inventory. This will initially keep home prices relatively flat. However, as inventory is absorbed, market conditions will tighten in the absence of a large-scale increase in home completions, ultimately leading to a resumption of price growth."
-Jason Mercer, TRREB Chief Market Analysis
What Lies Ahead for Canada’s Housing Market?
The Canadian housing market is currently showing a mixed performance across regions. Ontario is seeing declining prices, while Quebec and Alberta are experiencing steady growth.
With the impact of recent rate hikes still playing out, Ontario (especially the GTA) could continue to see price moderation. Time will tell how these dynamics unfold, but it’s clear that rate cuts alone won’t necessarily provide the immediate boost some might expect for the housing market.
This historical perspective reminds us that while lower rates can improve affordability, they don’t always translate into higher home prices. Understanding the broader economic factors at play is key to navigating Canada’s real estate market.
