Canada's Housing Bubble

Jun 07, 2010 Michael Babad theglobeandmail.com

Consequences of rising rates, record debt may be ‘dire,’ National Bank warns

The effect of rising rates on real estate

National Bank of Canada worries that the impact of rising interest rates on the residential housing sector “could be dire” in Canada.

“Though the Bank of Canada has done well to set its rate normalization process in motion, the fact remains that the stakes at play are high, with home prices and household debt at record levels relative to income,” economists Matthieu Arseneau and Yanick Desnoyers said in a report today. “... The residential real estate sector, which is extremely sensitive to interest rate fluctuations, could have the wind knocked out of its sails if interest rates do nothing more than normalize.”

The two economists studied previous periods of rising rates, given that the Bank of Canada last week began hiking its benchmark overnight rate from the emergency low it used to fight the recession. The fall in rates increased the borrowing capacity of Canadian families, they said, in turn helping to drive home prices to levels that, as a percentage of personal disposable income, have never been higher.

“Whereas a 100-basis-points increase would have meant an extra $101 in 1994, the same hike would amount instead to $177 today,” they said, looking at the impact on a three-year mortgage. “... In order to take into account the fact that household ability to pay has changed over time, we represented this amount as a [percentage] of the income of a two-parent double-income with children family. Accordingly, the impact of a 100-basis-points increase in the three-year rate on monthly mortgage payments is 18 per cent higher today than it would have been in 2004 and 14 per cent higher than it would have been in 1994.”