Demand for homes is so strong that high rates and new lending rules will likely affect only a handful of consumers.
A booming Canadian economy has prompted the Bank of Canada to hike its lending rate a quarter of a point for the third time since last summer.
In the near-term, it will likely mean some belt-tightening among those with variable rate mortgages and lines of credit, and with more increases expected, some consumers will be scrimping further as the year goes on.
But the demand for housing in the Toronto region remains so strong that the higher mortgage rates aren’t expected to have a big impact on home sales.
The Bank of Canada’s move to increase the benchmark rate to 1.25 per cent, which will drive up variable mortgages and consumer loans, was widely anticipated and comes only about two weeks after new mortgage stress testing rules were introduced by the Office of the Superintendent of Financial Institutions (OFSI).
The .25 per cent increase would mean an additional $52 a month or $624 per year on payments of a $400,000, 5-year variable rate loan amortized over 25 years, according to Ratehub Inc.
Royal Bank of Canada was first among Canadian banks to respond to the rate hike, raising its prime lending rate by a quarter of a percentage point, to 3.45 per cent, effective Thursday. Bank of Montreal, CIBC, Scotiabank and TD Canada Trust followed.
The volume of home sales in the first two weeks of January is 6 per cent lower than the same period last year when the Toronto area market frenzy was building to its April peak, said John Pasalis, the number-crunching president of Toronto brokerage, Realosophy.
“The mood overall is relatively positive. A lot of buyers need to buy a house,” he said, speculating that many of those are jumping back into the market, after putting their home search on hold last year.
But Pasalis doesn’t discount the financial stress that is mounting on homebuyers and owners, who have stretched their budgets to get into the market. They won’t default on their mortgages but, he said, “When you’re in an environment of rising expenses and costs that puts pressure on people.”
A December survey for CIBC showed that paying down debt is a priority for 2018 among 25 per cent of consumers. Last year, the Financial Consumer Agency of Canada warned that many are struggling to do that. It found 40 per cent of the three million Canadians who have home equity lines of credit — with an average $70,000 debt — don’t make regular payments on those loans. Twenty-five per cent make only minimum payments or pay the interest.
The central bank has hinted that further rate boosts are possible this year, but it said it would be assessing the impact of higher rates on the economy.
Increased loan costs are one more step in the return to “normality” after 10 years of low lending rates, said James McKellar, associate dean at the Brookfield Centre in Real Estate & Infrastructure at York University’s Schulich School of Business.
“If (the interest rate) does have a dampening affect on the housing market no one’s going to really suffer that much. There’s an incredible amount of demand and people seem to have access to money,” said McKellar.
He suggested higher rates could prompt consumers to reconsider expensive car loans and high-priced internet and phone services.
The Bank of Canada cited robust employment, an unexpectedly strong housing sector and inflation that is close to target as reasons behind Wednesday’s rate hike. Clouding the picture, it said, is the uncertainty around the North American Free Trade Agreement.
The strong economic factors underlying the rate rise also apply to the Toronto area housing sector, said Tom Storey, sales representative for Royal LePage Signature Realty.
“I know interest rates went up but they’re still historically low. Vacancies in Toronto are still under 1 per cent, the rental demand is off the charts,” he said.
Housing demand is compounded by high immigration levels that is attracting newcomers to cities like Toronto.
“Even if the (interest rate) increase were to take a handful of purchasers out of this market, the number of properties available in this region is just not large enough to sustain the current levels of demand,” said Storey.
The impact of the OSFI changes won’t be clear until March or April because many buyers avoided them by getting pre-approved for up to 120 days at the end of last year, he said.
On the new construction side of the housing market, it’s unclear how investors will react to the higher interest rates, said analyst Ben Myers of Bullpen Research.
There should be some relief to the currently limited supply of housing three years from now. A balanced supply and demand market in the Toronto area would mean between 25,000 and 30,000 condo completions in a year. Last year there were 18,232.
“We’re not likely to have any years over 30,000 until at least 2020 looking at the preconstruction sales and the typical lag between sales and completion,” said Myers.
The demand to rent condos is likely to remain strong given the low vacancy rates, higher interest costs and tougher lending rules that might sideline some would-be buyers. But investors will weigh those conditions against the lower returns from Ontario’s expanded rent controls on new buildings.