Rate Hikes by Canadian banks might lead to Collapse in Canadian Housing Market

The Bank of Canada is now threatening to conduct a rate hike that will be occurring later that could take effect Canada’s housing market.

 It could even trigger a multi-year 25% collapse in housing prices. The raise of rates is done to stop inflation. And it is said that in the coming low inflation environment, the debt burden doesn’t go down and as normal rates remain low and the wage growth also slows. This situation will make housing less affordable in the years to come as the debt levels remain high.

The situation of the Canadian housing market if rate hikes progress

The value of houses in Canada is about 5.5 times the leverage disposal income, and the present fair value of a house is about 3.5 times above the price of the disposable income.

The action of rate hike increase would mean that a home owner with a $250,000 mortgage from the new rate of 5.85% with a 25-year amortization would pay about $1,577 per month signifying that the home owner would pay $88 more from paying $1,489 per month before the rate hike.

Rate hike’s effect on Canadian economy

This would mean that if the Bank of Canada will get a rate hike this year, it could easily lead to a house price collapse. And if house prices do fall, the effects on consumer spending and housing investments would be significant and maybe even be strong enough to take the economy into another recession.

Falling home prices could also cause unemployment, because the demand for new and existing homes fall as prices fall. People would often have the option to buy at the top, rather than like a very few, buy at the bottom in any market. Falling prices are seen as negative in the basis of purchasing assets. As prices fall, buyers become scarce.

Also, in the broader economy, wealth effect spending would dry up as home equity extraction is highly correlated with house price increase. The result will be that unemployment is inversely correlated with house prices.

What would be the future of the Canadian housing market

The real problem that this situation will cause is credit deflation. If that would happen, the situation will be more likely to follow the situation between the USA and Japan where real estates has gone bust amidst very low interest rates. And as deflation will pull on employment and wages, commodity price inflation will sap living standards which will not be a pretty sight.

Hopefully, any rate hikes this year will be unwound as a simulative measure as housing and the bigger economy cools down.