RBC: Housing Affordability Won’t Spark Crash

Mortgage-Carrying-costs Low rates have underpinned Canadian home prices for several quarters.  It makes you wonder what will happen when mortgage rates normalize.

RBC economist, Robert Hogue, wondered the same thing, so he performed a study that simulated a return to “normal” rates. (He defines normal as roughly 150 basis points higher than today, based on long-term inflation-adjusted averages.)

The effect of Hogue’s simulation was that home ownership costs jumped from 41% of pre-tax median family income (today) to 46%. The long-term average is 39% and in 1990 it hit 54%.

If we assume median income to be $67,000, for example, it suggests that normalizing interest rates would drive up home ownership costs by roughly $279 a month for the typical household.

This resulting drop in affordability would “continue to cool demand for housing in Canada,” but not pull the rug from underneath it, says Hogue.

The exceptions may be places like Vancouver and Montreal, in which demand could drop “substantially,” he writes.

Here is RBC’s full report. Hogue calls housing affordability “the best measure of underlying stress” in the real estate market. See page 9 of this for RBC’s affordability calculation methodology.

  1. “It makes you wonder what will happen when mortgage rates normalize.”
    What is normal? The average for the last 10, 20, 30 years?
    I think what comes out of this recession will be a new “normal”.
    We are told that all jobs lost in the recession have been recovered, yet we still have 8% unemployment, vs. the old 6% average. Some people think these jobs are lost forever (i.e. structural unemployment).
    People’s perceptions on things like personal debt levels, personal savings, investing in riskier financial products and consumer confidence are beginning to change. They have already started changing in the USA.
    I think what emerges out of all of this change will be new “normals” for things like interest rates, mortgage rates, investment return rates. I’m just not sure whether the new norm will be higher or lower than the old one.
    Another point. People seem to cite the 25 year amortization as the norm for a typical am. I work in health care. People are living much longer these days and the average life expectancy will only increase with further medical advances in the future. I see reason why this 25 year am can’t be stretched to 30, 35, or beyond in the future. I can’t remember which one, but a European Country just increased it’s retirement age to 67. This will eventually come to the West as well, IMO. As long as people are working there’s no reason why they can’t handle a longer am. I think ams will continue at 30-35 years or possibly incrase in the future, not revert to the “old” normal 25 year am.

  2. When you have a mortgage broker that you are considering, schedule an interview. You will need to provide financial information to the broker so that he or she can begin looking for a lender for you. However, this is the time for you to learn if you are comfortable with the broker. Remember, you will be living with your mortgage for a long time, so you need to feel confident that your broker is looking to find you the best possible deal.

  3. People may live longer but more of their lives are also consumed by education as you now often need multiple degrees to get a job or switch careers when your old one gets off-shored. The end result is that our working years haven’t increased nearly as long as our lives have. Thus, assuming 40 working years on average, 25 years to pay off the mortgage and 15 years to save for retirement seems about as right now as it did 30 years ago.

  4. There is always some level of structural unemployment as the labour market adjusts to structural changes in the economy. That means that while some jobs are “lost forever”, others are created to take their place.
    The long term picture still points to a tightening labour market as an aging population and low fertility rates limit labour force growth. The recession didn’t change these longer-term drivers.
    The post-recession performance of the labour market has been very strong – much better than most analysts predicted.

  5. The recession also didn’t change the fact that there are 4 billion people in the emerging countries eager (and able thanks to free trade and technology) to do our jobs at a tiny fraction of the cost. That trend, and immigration, will more than offset any demographics induced labour tightening in the Western countries.
    As for jobs, everyone needs to eat so unemployed people will settle for anything eventually. What matters is the job and wage growth. One without the other is not necessarily a positive sign.
    Back on topic, an extra $279 per month alone may not do much, but add in the extra UI premiums, HST, energy price increases, etc. in an environment of minimal wage gains and that rug under housing may get pulled faster than many think.

  6. Al and wjk. Agreed except for one point: that “everyone needs to eat, so umployed people will settle for anything eventually.”
    Not in Canada! Most people have already figured out it’s better to go on EI/welfare than just settle for a job.
    I have met many farmers that have had to bring in workers by the busload every year from Mexico because Canadians are somehow too good for that kind of work, all the while we have 5-8% unemployment.
    Lots of people in Canada have figured out that its easier to milk the system than work for minimum wage. I heard about another one last evening at dinner. A friend of a lady I was takling with has been on welfare/EI/ODSP for the last 20 years, probably only working a combined 2 or 3 years out of those 20. She said she had no desire to work because with welfare and her childcare credits she makes about 2/3 of what she would be making at minimum wage anyway! On top of that she moves to a new city every couple of years because once the Welfare office figures out what she’s been doing they threaten to cut her off (and apparently the Welfare offices don’t share information well), and she usually screws over a landlord for several months rent at the same time!
    There are lots of people like this and they aren’t even counted in the unemployment figures because they’re never looking for work! God Bless Canada!

  7. Is it really true that Canadians think they are “too good” to work as produce pickers? There are lots of Canadian construction workers, garbage men, auto mechanics, etc. doing work as dirty and hard or worse so I’m not sure about that. Perhaps it has more to do with the fact that our government allows desperate
    foreign guest workers into certain fields (like Mexican produce pickers and Philipino nannys) and they have driven wages down in those fields to where Canadians are better off going into substitute fields like construction that pay better wages.
    On the topic of welfare, what you describe is an unfortunate but natural response to a lack of living wage jobs for Canadians with low or unmarketable skills. Folks get desperate if they can’t find a job that covers their living expenses. That’s pretty hard to do in a place like Toronto, especially if you’re a single parent with neither skills nor a family to help. In fact, I truly can’t fathom how any single parent could do that on minimum wage in Toronto. With dental and other perks included, folks on welfare can often do much better than those on minimum wage especially if they supplement it with under-the-table (but hopefully otherwise legal) income. It’s really too bad that some people get caught in the welfare trap but I can sort of understand why.

  8. I don’t think it has to do with the perceived dirtiness of the work but simply wages.
    The jobs I was referring to that Canadians are “too good” for aren’t construction, auto mechanics or garabage men. These jobs are considered “skilled labor” (with the exception of latter I suppose, which is still a government job…enough said) and are paid well.
    I was referring mostly to unskilled labor that has to make due with minimum wage. I guess you could also include some skilled labor in this category, such as cancer researchers.
    For me at least, I don’t consider myself too good for any job and would do whatever it takes to put food on the table even if that was picking produce for 10 bucks an hour.
    I had to leave my job as a cancer researcher at a hospital in Toronto to work at a bank so I could make a living, until I was able to get a decent paying job in the USA. Many of my colleagues (PhDs and MDs) have also left for Europe and the US (mainly) to get good paying jobs. It seems like such a waste of talent especially when the Canadian government invests so much to put as through all that school.
    I find people here in the US are much more inclined to take a low paying $6-$10 per hour job, although there are still bumbs like anywhere else. I’m not quite sure why this is, maybe just because they know the government won’t carry them as long?

  9. Another fundamentally flawed Article.
    ” drive up home ownership costs by roughly $279 a month ”
    Where do they dream up these numbers from?
    Are they assuming that EVERYONE who has a mortgage is both (a) on a variable rate and (b) timed the market to perfection to get in at the very bottom?
    The majority of fixed rate homeowners likely have rates currently of 5 to 6.5%. I’m intentionally ignoring those who were lucky enough to buy a house in the last 18 months during the “lowest ever recorded” rate period.
    So, no, home ownership costs are not being “driven up by $279 a month” for the majority – only for those who have been fortunate enough to pay rock bottom prices in recent months and haven’t locked in to a longer term yet.
    For the vast majority already on higher rates, when their renewal comes due in the next 1 to 3 years, they may even see LOWER monthly mortgage costs, unless the rate is over 6.5% by then.
    So, really, before these writers pen these one-sided articles, they should give a little context about how SOME people may pay more but many others may just as likely pay LESS.

  10. Hi Robert,
    I’ll try to address the flaws you perceive.
    To start with, note that RBC’s simulation reflects the estimated cost difference of taking out a new mortgage today, versus after rates climb 150 basis points. Remember that decreases in housing affordability affect demand by buyers at the margin, which has a key bearing on home prices. Mortgagors who are simply renewing have less impact on housing demand (unless they can’t afford their house anymore).
    In addition, the housing cost increase referred to in this article is measured against median numbers. It doesn’t mean that everyone’s monthly payments will rise, nor does it suggest that the increase will be $279 a month for all.
    The essential point Hogue is making is that affordability will decline from today, but it won’t be catastrophic to the market. Take that for what you will.
    Regarding the rate held by the “majority” of fixed rate borrowers: Most mortgage holders have purchased, refinanced, or switched in the last 36 months. A great number have taken variables or shorter-terms than a 5-year fixed. For those who have taken a 5-year fixed, their average discount has been roughly 1.40% off posted rates (CAAMP cites 1.46% in its most recent survey), and posted rates have averaged 6.34% in the last three years.
    Therefore, the average rate held by fixed borrowers is below the range you cite. Moreover, a 150 basis point increase from today would potentially put most 5-year borrowers above the rates they’ve received in the last three years.
    All the best,
    Rob

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