The new housing affordability 'crisis' will be driven by higher mortgage rates, not higher home prices

Haider-Moranis Bulletin: What is eroding housing affordability is the increase in mortgage payments from higher rates for prices at historically high levels

A recent report by RBC Economic Research warned that housing affordability continues to worsen in Canada. The ownership costs for a home bought in the second quarter of 2018 now consume 53.9 per cent of a typical household’s income.

The RBC report claims that housing affordability has not been this bad in Canada since the early nineties. In large metropolitan areas that saw a rapid acceleration in housing prices, such as Vancouver and Toronto, housing carrying costs could claim upwards of 75 per cent of a typical household’s income.

What is driving the latest housing affordability “crisis” is not necessarily a sustained increase in housing prices, but instead an increase in mortgage rates that require a larger share of a typical household’s pre-tax income to cover the mortgage payments.

The RBC report reveals that the increase in housing prices was not commensurate with an increase in household incomes. So how did Canadians continue to afford homes as prices increased, but their incomes didn’t? The answer is cheap credit and mortgage regulations that promoted binge household borrowing.

Mortgage rates are a double-edged sword. When low, they fuel price inflation and worsen housing affordability. When prices are eventually higher, an increase in mortgage rates further worsens affordability because carrying costs are highly sensitive to lending rates.

Record low mortgage rates, the sustained increase in the size of mortgage loans, and the ability to stretch one’s mortgage to 40 years and beyond meant that households could afford to purchase even more expensive homes despite their stagnating nominal incomes and, in many cases, declining real incomes.

The usual drivers of an increase in housing prices are higher housing demand resulting from an increase in population or income levels. The increase in the Canadian population is mostly driven by immigration. The increase in urban populations is even more dependent upon immigration levels. The population-based increase in demand is, therefore, a matter of public policy that determines the number of immigrants being allowed in the country.

On the other hand, the increase in household incomes is not necessarily determined by public policy. A growing, innovation-driven economy will induce higher incomes. That’s not true for large cities in Canada where a growing segment of recent expansion in jobs is in part-time employment, which is hardly a driver of wage growth needed to support either an increase in consumption or the prices of consumer durables.

The usual suspects for housing price inflation have neither been an excessive out-of-control demographic pressure or higher wages. Hence, when ownership costs are pegged against typical household incomes, one could see the erosion of housing affordability over the past decade.

Household consumption in Canada has essentially been supported by an increase in household debt, which recently broke through the two trillion dollar threshold. Most of the household debt is tied up in the mortgage markets.

The increase in Canadian housing prices was largely driven by the increase in prices in Toronto and Vancouver. The respective provincial governments in 2016 and 2017 took measures to decelerate the growth in housing prices. Furthermore, the stress tests imposed on lenders regulated by OSFI further moderated the rate at which house prices were rising.

The increase in Canadian housing prices was largely driven by the increase in prices in Toronto and Vancouver. Cole Burston/Bloomberg

Hence, the recent worsening of housing affordability is not because of the rapid increase in housing prices. What is eroding housing affordability is the increase in mortgage payments resulting from higher mortgage rates for housing prices that still stand at historically high levels.

The age of cheap credit appears to be over where mortgage rates are likely to increase in the future pushing the carrying costs even higher. The true effects of the tightening mortgage markets will be felt later when the existing borrowers will return to renew their mortgages at higher rates.

The last time housing affordability was this bad in Canada was in the early nineties when mortgage rates were in double digits. The ensuing recession contributed to a lost decade for housing when prices either stayed flat or declined.

Though mortgage rates have inched upwards as of late, and are likely to increase in the future, yet they remain at historically low levels and are unlikely to trigger a major correction in housing markets.

The housing affordability challenges, therefore, are likely to stay with us for a long time.

Murtaza Haider is an associate professor at Ryerson University. Stephen Moranis is a real estate industry veteran. They can be reached at

