How Rising Interest Rates Are Affecting Buying Power

Anyone interested in Canadian real estate has been paying close attention in the past six months as the market has shifted dramatically across the country. News articles are released daily discussing rising interest rates, inflation, and downward trends in real estate prices that collectively affect neighbourhoods across the country.

This article will provide a deep dive into the concept of home buying power and how it has been affected by policy and market changes. We will touch on buying power, why real estate prices are falling and how that affects individual homeowners’ equity and contributes to large movements in the housing market. Next, we will look into the steadily increasing mortgage rates and discuss how making mortgages more expensive affects affordability and impacts the demand for homes.

We will also consider some recently released and very telling statistics to get a practical understanding of how these shifts are playing out nationally. Finally, we will touch on what buyers and sellers should consider during these turbulent times and how Loyal Homes can help our readers with their upcoming or current real estate decisions. 

What is Buying Power

Before diving into the markets and the regulatory environment, let’s clarify what Buying Power means. When purchasing a home, buying power is simply the amount of money a potential purchaser has available to put toward the purchase. This is typically a combination of your savings and any funds you can borrow, which is determined by several factors, including your income, savings, and credit history. These components in turn, affect the amount you can borrow through a mortgage, as it helps various financial institutions (such as banks and credit unions) determine your borrowing ability. Your buying power is an important consideration because it determines how much you can afford to spend on a home and can ultimately affect the type and location of the property you can purchase. 

For example, if you have a high buying power, you may be able to afford a more expensive home in a desirable neighbourhood. On the other hand, if your buying power is limited, you may need to look for more affordable options in less expensive areas or consider smaller homes that may not fit your ideal needs. We’ve already touched on some of these effects in articles such as “BC Home Buyers May Flock To Get Mortgages Due to Rate Rise.” 

So, surely buying power is generally increasing with falling real estate prices? Unfortunately, it is not that simple, especially in an environment with rising interest rates. For most buyers, there are two components to the buying power - savings and the mortgage. We will touch on these two intertwined components below and explore how they are relevant as real estate prices fall.

The Effects of Falling Real Estate Prices

Consider the Canadian Real Estate Association’s monthly report from November. Although the first stat they point to is a slight uptick in national home sales month-over-month, they also report a 36% drop in monthly activity compared to October of the previous year. After a frantic 2021, with home sales spiking to record levels, data across the board has since normalized below the 10-year monthly moving average. This succinctly demonstrates the wide-scale shifts that are occurring. It is fair to believe that with additional available inventory, prices will drop to accommodate a wider range of offers - simple supply and demand.

Reductions in real estate prices have a few critical effects. The first is that the value of the property decreases. Property price decreases affect investors of all sizes, from large investment arms of pension funds invested in new developments to smaller one-off investors in sectors like pre-sales, who are completely reliant on capital appreciation to turn a profit. Institutions and individuals can find themselves underwater as they realize that they may not be able to sell their investment for a guaranteed profit - a stark contrast to the steady appreciation experienced in the last decade and the dramatic jumps of the past two years. 

For homeowners looking to refinance their mortgages, changes in the assessed value of their homes mean that they may not be able to borrow nearly as much based on the lower value of their house. Typically, falling prices should make it easier for prospective buyers to afford a home, as the lower prices increase their available buying power. In many countries around the world, the average citizen has been patiently waiting for a drop in prices to get their foot in the market. 

For years, the provincial and federal governments have worked to increase affordability through tax breaks, First Time owner buying plans, and other methods intended to help Canadians get onto the property ladder. Many of these efforts were also tied to a historically low period of interest rates, which provided the ability for many people to afford homes that would be out of reach in a higher interest rate environment. As most readers are aware, the drop in home prices has also been impacted by rapidly rising interest rates, negatively impacting many potential buyers who have patiently waited on the sidelines. Check out our First Time Home Buyers in BC for more information.

The Effects of Rising Interest Rates

These rising mortgage rates are inextricably linked to buying power and overall housing prices. As interest rates rise, it becomes more expensive for prospective buyers to borrow money to purchase a home, which can reduce the number of potential buyers in the market. This, in turn, can lead to a decreased demand for homes and a corresponding price decline. 

Rising interest rates can also make it difficult for existing homeowners to afford their mortgage payments, leading to an increase in foreclosures and further downward pressure on prices. When mortgage interest rates increase, the monthly payments on a loan also increase. This can make it less likely for homeowners on the edge to be able to afford their monthly payments, especially if they have a variable-rate loan that rises on them somewhat unexpectedly.

Generally, rising interest rates make it more difficult for potential homeowners to borrow and for current owners to continue servicing their mortgages. We covered the difference between Fixed and Variable mortgages here, which has become a much more relevant topic as interest rates rise. Those choosing a variable mortgage are gambling that the payment will remain low, but when the banks are directed to raise rates by the central authority, it can quickly become unaffordable for those who purchased a home that was near the brink of their buying power at the time. 

This is a useful time to remind readers of stress testing, favoured by the banks, to see how much money they can lend you. Before taking out a mortgage, the lender will “stress test” the buyer by seeing if they could afford the same mortgage if rates changed. Your qualifying rate is determined based on current rates of +2%. The Big five banks and other institutional lenders generally hedge their risk better than smaller boutique lenders.

So, a homeowner who bought their house at the peak price in 2021 is now faced with a combination of falling prices and potentially rising interest rates. If they selected a variable-rate mortgage, they might need to consider adjusting their budget to accommodate a higher monthly payment or a longer mortgage. 

Those on a fixed-rate mortgage who were able to secure a low-interest rate are now off to the races, as they have likely secured some of the lowest rates that will be available for years to come. Unfortunately, the variable rate mortgage was so appealing that nearly 50% of all mortgages purchased in 2021 in BC were variable rates, which means that many of these people will be facing rising monthly payments.

Doom and gloom aside, is there opportunity amidst this mess? For prospective buyers, the combination of falling prices and rising interest rates can create opportunities to buy a home at a lower price. Still, they may need to budget carefully to afford the higher monthly mortgage payments. This could be a good time for those who have amassed a sizeable down payment. However, with so much uncertainty in the market, one must carefully consider their purchase, particularly if it is intended as an investment. 

If you are curious about what a home purchase might look like in 2023, this may be a good time to connect with our Client Care Coordinators. Our team of experts provides clear, concise advice to British Columbians at any stage of their home-buying journey. This is a good place to start if you are looking for general advice. If you require professional help, our team can also connect you with our extensive network of vetted experts who share our commitment to the highest level of customer service in real estate.

Conclusion on the Effects of Buying Power

In conclusion, the recent rise in interest rates has significantly impacted the Canadian real estate market, leading to a decline in prices in many communities. This trend will likely continue as interest rates rise, making it more difficult for prospective buyers to afford a home and reducing their buying power. 

However, the decrease in prices also presents an opportunity for those waiting to enter the market, as lower prices can increase their buying power and make it easier for them to afford a home. It remains to be seen how the market will continue to evolve. Still, it's clear that rising interest rates and falling prices are having a major impact on the Canadian housing market and the ability of Canadians to become homeowners.

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