Affording a House Today

Affordability-of-your-mortgage Affordability is a key determinant of housing demand. That’s one reason why RBC measures it regularly (here’s its latest report).

Housing affordability is especially relevant nowadays in light of the media debate about real estate bubbles. For more insight on this we spoke with one of Canada’s authorities on home affordability, RBC senior economist, Robert Hogue. Hogue is author of RBC’s Housing Affordability Measure, which makes headlines whenever it’s released.

Hogue notes that “Extreme readings of unaffordability have corresponded to bubbles in key markets in the past.” So the first question that comes to mind is: How does affordability look currently?

At the moment, Hogue says the ratio of home ownership costs to income is just “slightly above long-term averages“ and “well below (i.e., better than) the recent cyclical peaks reached in early 2008.”

The worst reading on record was in the first quarter of 1990. Back then, poor affordability “certainly did have an impact on market activity after that.”

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RBC’s Housing Affordability Measure gauges the share of typical household income that would be used to own a home at current market prices. Among other things, it’s impacted by mortgage rates, lending policies and home prices.

Interest rates are especially critical. “When interest rates go up, affordability is likely to deteriorate,” Hogue says. “A 2% (rate) increase would place our affordability just below early 2008 (the most recent extreme).”

Despite affordability’s impact on housing demand, Hogue confirms that it’s not always possible to make a direct link between affordability and home prices. That’s because prices are established not only by demand, but by supply. Poor affordability can certainly reduce demand, but the effect on prices could theoretically be nil if offset by tighter supply.

That said, Hogue notes that “supply and demand do tend to move together over time.”

If you’re interested in how RBC’s Housing Affordability Measure is calculated, it’s based on:

  • Mortgage payments
  • Heat; and,
  • Property taxes

The sum of these expenses is divided by median household income to derive RBC’s Housing Affordability Measure.

RBC quotes three ratios actually. There’s one for each of the three standard home types, as defined by Royal LePage: two-storey homes, bungalows and condo apartments. These different home types are all “almost perfectly correlated,” says Hogue.

The closest thing to an “average” Canadian home is the detached bungalow. It takes 40.5% of the typical Canadian’s household income to afford a bungalow, according to RBC’s May report.

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Interestingly, Hogue notes that most households in the middle of the national income distribution “would not be able to afford a detached bungalow (today).”

RBC’s affordability analysis is a good long-term benchmark for trend analysis, but it’s unavoidably imperfect. That’s because the mortgage payments that it’s based on assume:

  • Posted 5-year fixed rates
    • Using posted rates is a bit unrealistic given that few people actually pay posted rates
    • Posted rates are used because the index goes back to the mid-1980s and there are no time series of discounted rates going back that far
  • A 25-year amortization
    • Only 39% of home buyers getting mortgages in the last 1.5 years took an amortization of 25 years or less (Source: CAAMP)
    • The government’s recent reduction in maximum amortization (from 35 to 30 years) “does raise the bar, especially for first-time buyers,” Hogue states. “It will cool demand….We’ll see what the supply response is.” (First-time buyers represent about half of all home sales in Canada.)
  • A 25% down payment
    • 79% of home owners have 25% or more equity (Source: CAAMP)
    • Yet, 61% who bought homes in the last 1.5 years put down less than 20% (Source: CAAMP)
  • No condo fees
    • Condo fees are not included in RBC’s calculation because consistent data is not available over time

There’s also been a steady rise in non-housing debt since RBC’s affordability measure first launched in the 1980s. For this and other reasons above, we’re left wondering if the next extreme in unaffordability (that precedes a housing correction) will be lower than those in the past.


Rob McLister, CMT

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