The US Federal Reserve raised interest rates for the second time this year bringing the US bank rate above 1% for the first time since 2008. During the same week, the Bank of Canada signaled the end to low interest rates is coming and the next interest rate move will most likely be up and not down. Does this spell doom for Canadian home prices? Probably not.
If you’ve been waiting on the sidelines and expect a Boxing Day sale on home prices you might be gravely disappointed. The fact remains that housing remains in high demand and the Canadian banks are better protected than their US counterparts on mortgage defaults. A measly 25 basis points in interest will do little to cool the market in the way that most people want.
Fixed Term Interest
First and foremost let’s not forget that the most popular mortgage in Canada is a 5 year fixed rate mortgage. Canadians are a conservative bunch and the majority of home owners prefer the safety of fixed rate over a variable. This means many home owners are already tied into long term mortgages that are at a very low rate of 1.8-2.3%. These owners won’t be up for renewal for another 5 years, so if they were able to afford their mortgages when the house was bought there is no reason to believe they can’t keep paying their mortgages for the near future.
This 5 year window gives owners a chance to raise their income or save up for a large lump sum payment when their mortgages come due for renewal 5 years down the road and mortgage rates are higher. Score one for housing prices!
CMHC Got Your Covered
What got banks all worried in the US in 2008 was that many home owners were underwater in their mortgages and couldn’t actually pay their mortgage once their subprime mortgages were due for renewals. Considering how US banks allow non-recourse mortgages, where owners could walk away without consequences, this created a situation where banks sat on a plethora of housing inventory and no buyers. But why would banks want to hold houses? They want to hold mortgages. This led to a quick sale of many homes causing a large correction of home prices in a short period.
This doesn’t hold true in Canada. We generally don’t have non-recourse mortgages. Owners are on the hook if they try to walk away from their mortgages or be forced to declare bankruptcy and lose everything. There is much more incentive for a home owner to continue paying their mortgage even if they are underwater. Canadians would rather go out less to Red Lobster or The Keg than risk defaulting on their mortgage. Perhaps iPhone sales will fall, but I doubt that one.
Additionally, should a home owner default, banks don’t need to rush to get their equity back right away because they are covered by the taxpayer through CMHC. The banks will get their money back, but the general public will just get hit by a higher HST or income taxes to make up the bail out to the banks. Don’t worry. The banks are already covered thanks to our generous Canadian government. This means there’s no need to do a quick sale and banks can thus try to get the best possible value for the homes they repossess. Score another one for home prices.
Owners Still Think It’s Hot
What makes home prices stay high? Perception. As long as the general public continues to believe that houses are worth one million dollars, they’ll continue selling for one million dollars. Even if buyers balk at paying such a hefty price, home owners will continue to feel that their houses are worth more than what buyers are bidding.
If there is no incentive to sell, house prices will continue to stay high for the near term. There is no way to judge the price of a house other than a he said, she said dilemma. If the seller is unwavering in the price that a buyer is offering, there will be no sale. Prices won’t fall. At least not until interest rate hikes or unemployment make it unbearable to afford mortgage payments.
This phenomenon doesn’t happen overnight. It’s not likely to happen that come July people in their houses will be struggling to pay their bills and be desperate to sell their million dollar homes at a discount. Logically that makes no sense. If anything sellers will actually RAISE prices in the near term to attract buyers. It sort of reverse psychology because as prices rise higher and higher buyers will feel the market is getting away from them and they’ll need to purchase. It’s now or never right?
Score another one for home prices!
Don’t Consider The House An Investment
As I’ve mentioned before, don’t buy your principal house as an investment. Buy it because it’s what you want and it’s what you can afford. If home ownership is your life dream and you want that lifestyle because everything else doesn’t matter, then how do you put a price on happiness?
If you can be satisfied paying $1.4M over 25 years to live in a home that you can call your own and it makes you feel accomplished then perhaps home ownership is what identifies with you. It shouldn’t matter if home prices drop 20%, 30% or even 50%. You are still living your dream because home ownership is what defines your life. You bought that home because you knew you could afford the $56K payments a year and those are the sacrifices you were willing to make to pay for it.
See some people love cars and they are will to spend $20K a year making payments on a luxury car. That’s no different for a house. If that’s what you want then buy it. So as long as you are happy and it fits into your budget then price shouldn’t matter.
Of course if you’re one of these folks, like this investor with 5 houses, then pray that house prices continue up because while rent control and rising interest rates will put a damper on that return on investment. But WHY OH WHY are you putting yourself at such risk and putting all your eggs in one basket? I know I wouldn’t.
Expect Gradual Declines
Yes, I know everyone is expecting fireworks, but that’s not going to be the case. As interest rates gradually rise the cost of borrowing will get higher. This in turn will cause some correction in prices, but it won’t be an instantaneous, catastrophic drop off a cliff. For all the reasons that I’ve already mentioned above, prices will remain sticky.
Canadians could expect a long slide in prices as rates rise over the coming years, but is that going to put you off of buying for the next 3, 4 or 5 years? That’s only for you to determine. As I’ve mentioned, if home ownership is what defines your life, perhaps you don’t want to hold off on the purchase. Be content with what you can afford now and be happy with your life.
If you’re an investor that’s super leveraged over 40 times your income on real estate, then I pray for your financial well being.