The Canadian housing market has been on a roller coaster ride for the past two decades, with prices soaring to unprecedented levels in some regions, while incomes have lagged behind. In this article, we will explore some of the factors that have contributed to this situation, and what it means for the future of homeownership and retirement savings in Canada.
The Impact of Low Interest Rates
One of the main drivers of the housing boom has been the low interest rates that have prevailed since the 2008 global financial crisis. Interest rates are the cost of borrowing money, and they affect how much people can afford to pay for a home. When interest rates are low, people can borrow more money and pay less interest, which makes buying a home more attractive. Conversely, when interest rates are high, people can borrow less money and pay more interest, which makes buying a home less affordable.
Interest rates today are historically low, but they were not always so. Twenty years ago, in 2003, the average mortgage rate in Canada was about 6%, compared to about 2% today. This means that a $500,000 mortgage would cost about $3,000 per month in 2003, versus about $1,800 per month in 2021. That's a huge difference in monthly payments, and it explains why many people have been able to buy homes that they would not have been able to afford otherwise. With today's prevailing interest rates, the monthly payment would be approximately $3,400.
However, low interest rates have also created a feedback loop that has pushed home prices higher and higher. As more people can afford to buy homes, the demand for housing increases, which drives up the prices. As prices go up, people expect them to keep going up, which creates a speculative mentality that encourages more buying. As more buying occurs, the supply of housing decreases, which drives up the prices even more. And so on.
This feedback loop has been especially pronounced in some regions of Canada, such as the Greater Toronto Area (GTA), where home prices have increased by about 700% in the past 20 years, while incomes have not even doubled. This means that the ratio of home prices to incomes has become extremely distorted, and out of sync with the fundamentals of the housing market.
The Challenge of Affordability
The fundamentals of the housing market are based on the concept of affordability, which measures how much of a person's income is needed to pay for housing costs. A common rule of thumb is that housing costs should not exceed 30% of a person's income. However, in some regions of Canada, such as the GTA, the average housing cost is now over 60% of the average income. This means that many people are spending more than half of their income on housing alone, leaving little room for other expenses or savings.
One way that some people have been able to cope with this situation is by relying on the "bank of mom and dad" to help them buy homes. This refers to the practice of parents giving or lending money to their children to help them with their down payment or mortgage payments. According to a recent survey by CIBC, about one in four first-time homebuyers in Canada received financial help from their parents in 2020.
However, this approach is not sustainable in the long term. One day, mom and dad will need their money back for their own retirement needs. Moreover, this approach creates an intergenerational wealth gap between those who have parents who can help them and those who don't. It also perpetuates the cycle of high home prices by increasing the demand for housing without increasing the supply.
Viewing Homes as Retirement Savings
Another way that some people have been able to cope with this situation is by viewing their home as a retirement savings plan. This refers to the idea that by buying a home and paying off their mortgage over time, people will accumulate equity in their property that they can use to fund their retirement. According to a recent survey by RBC, about two-thirds of Canadians plan to use their home equity as a source of income in retirement.
However, this approach is also risky and uncertain in the current housing market conditions. One reason is that home prices may not continue to rise indefinitely, and may even decline at some point. This could erode or wipe out the equity that people have built up in their homes over time. Another reason is that home equity is not liquid or accessible unless people sell their homes or borrow against them. This could limit their options and flexibility in retirement.
The Temporary Nature of Mortgage Relief
The only reason we have not seen a major housing crash in Canada yet is because banks have been lenient and accommodating with borrowers during the pandemic. They have allowed many homeowners to defer their mortgage payments or extend their amortization periods (the length of time it takes to pay off a mortgage). This has helped many people avoid defaulting on their loans or losing their homes.
However, these measures are temporary and cannot last forever. Eventually, homeowners will have to resume their normal payments or face higher interest costs over time. This could put pressure on their finances and force them to sell their homes or reduce their spending on other things. This could also have a negative impact on the economy and the housing market as a whole.
Possible Solutions
In conclusion, the Canadian housing market is facing a serious challenge that requires a serious solution. One of the following must happen:
- Incomes must catch up to support the current home prices and allow real estate to continue going up. This would require a significant increase in wages and salaries across the board, which is unlikely to happen in the near future given the economic uncertainty and the competitive pressures of globalization.
- Home prices must go down to align with the current incomes. This would require a correction or a crash in the housing market, which would be painful and disruptive for many homeowners, especially those who are highly leveraged or have little equity in their homes.
- Amortization periods must increase, which would lead to never owning a home. This would require a change in the mortgage rules and regulations, which would allow people to borrow more money and pay less interest, but also take longer to pay off their loans or never pay them off at all. This would make homeownership more affordable in the short term, but more costly and risky in the long term.
None of these options are ideal or easy, but they are inevitable. The Canadian housing market cannot defy gravity forever, and it will eventually have to adjust to reality. The sooner we face this reality and take action, the better off we will be.