[Chronique de Gérard Bérubé] Difficult arbitration between fixed or variable rate and inaccessibility

The Bank of Canada intends to be more “aggressive” to bring persistent and generalized inflation back to its zone of acceptability and to prevent expectations from becoming unanchored. If the arbitration between fixed and variable mortgage rates is blurred, one certainty remains: property is becoming more inaccessible than ever. Unless a price correction occurs.

We were expecting a gradual rise in interest rates, spread over a longer period of time, with the Bank of Canada having to deal with high household debt and a vulnerable real estate market. However, the Central Bank warns that it will act more forcefully if the inflationary outbreak is long-lasting.

“We may have to raise rates a little above neutral for a while to restore the balance between supply and demand and bring inflation back to target,” she even warned. Wednesday on the heels of a 50 basis point hike to 1% in the overnight rate. The Central Bank now places its neutral rate in the 2-3% range. For their part, analysts are ahead of their target and now see the key rate around 2% at the end of 2022, an increase of 175 basis points this year.

If we retain this last target and if we estimate that each increase of 25 basis points is equivalent to $6 per month per $50,000 of mortgage, we would arrive at the end of 2022 at some $185 per month more on an average mortgage of $219,237 in Quebec, and $240 per month more on an average mortgage of $284,931 in Montreal, according to mortgage data from Canada Mortgage and Housing Corporation (CMHC).

In other words, this is equivalent to an increase of 18% on an average monthly payment of $1056 in Quebec (from $1308 in Montreal) at the end of 2021, assuming that the principal remains fixed. Thus, an increase of 100 points would be equivalent to an erosion of purchasing power of 10.7%, according to calculations by economists at the National Bank. Added to this erosion is the impact of the increase in the cost of money on monthly payments related to lines of credit and mortgage and personal lines, which totaled more than $880 on average for Montrealers at the end of 2021, again according to CMHC figures.

Of course, the Bank of Canada recalls that its key rate was 1.75% before the pandemic. But since then, home prices have jumped 50%. And between the fourth quarter of 2019 and the second of 2021, 70% of new mortgage debt was variable rate, Oxford Economics estimated.

These variable-rate loans accounted for 25% of outstanding mortgage loans last September, compared to 18% in February 2020. Seen otherwise, in September, 75% of outstanding loans were at fixed rates, of which the half had a maturity of five years or more. A scenario of a sharper rise in interest rates will have an impact on a greater portion of renewals.

One certainty: inaccessibility

This acceleration of the upward movement must be put in the perspective of home ownership which, at the end of 2021, recorded a fourth quarterly deterioration in a row. To use data from the National Bank, at the Canadian level, the repayment of the mortgage on a representative house monopolized 48.6% of the income of a typical household, the worst accessibility since the mid-1990s.

In Montreal, affordability fell for a fifth straight quarter to reach its worst level since 2008 and post the fastest deterioration since 1995. Mortgage payment as a percentage of income reached 38.5% for a representative property other than a condo, and 26.6% for a condo.

The Parliamentary Budget Officer observed on February 17 that house prices in Toronto, Hamilton and Ottawa were more than 50% above an affordable level by the end of 2021, and around 30 to 45% for Vancouver and Montreal. Oxford speaks of an average gap of 35% above the ability to pay.

There is no longer any doubt about the latter. A real estate price correction should start in the fall and last until mid-2024, under the weight of the record homelessness rate, the rise in interest rates and a rise in listings on the resale market. The research firm suggests a decline of 24% across Canada. Will have to see.

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