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Are mortgage rates driving up Toronto housing prices?

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Even though various elements impact housing demand, one that isn’t frequently mentioned is Toronto mortgage rates. When mortgage rates decrease, it becomes easier to borrow money. As a result, many new buyers rush to buy homes and drive up real estate prices. In Toronto, buyers are constantly outbidding each other and increasing housing prices.

Mortgage rates and their effect on demand for homes

In 2020, the Bank of Canada slashed interest rates 150 points to combat COVID economic damage. This monetary policy act decreased banks’ borrowing costs and enabled them to reduce their mortgage rates.

Although low mortgage rates do not directly affect real estate prices, it does cause an increase in buyer demand. When mortgage rates decrease, it becomes cheaper and easier to finance the purchase of a house.

Cheaper mortgage rates mean people can afford expensive homes. This means more people can afford properties in Toronto. The increase in qualified buyers due to lower interest rates helps drive up Toronto real estate prices. In the past 12 months alone, the average cost of Toronto houses increased by a record 13%.

Additionally, many first-time buyers can enter the market. To qualify for a mortgage in Canada, borrowers must meet a certain gross debt service ratio (GDS) threshold. When mortgage rates drop, it becomes easier to meet the GDS threshold. As a result, many new buyers qualify for a mortgage who were previously on the cusp. These new buyers rush into the market and outbid each other. All this action tends to drive up real estate prices.

At the same time, construction of new apartments halted in Toronto, leading to a shortage of supply. As a result, more homebuyers were competing over a lack of apartments and further drove up prices.

Why are Mortgage Rates So Low in Toronto?

Mortgage rates initially dropped in 2020 due to the bank of Canada’s slashing of interest rates. However, Toronto mortgage rates plummeted due to the competition between mortgage lenders.

Due to the similarity of mortgage products, lenders compete based on their interest rate. After the interest rate drop, many Toronto lenders lowered their mortgage rates to remain competitive. This started a price war in Toronto, where lenders raced to undercut each other. This competition between lenders led to some of the lowest interest rates ever seen in the city, as low as 1.6%.

Will Rising Mortgage Rates Cool the Toronto Housing Market?

Rising interest rates make it more expensive to borrow money. In areas like Toronto, where real estate prices are already high, this increase in cost could deter buyers. Also, if there is an interest rate shock within a short period, it can cause instability in the housing market.

For example, homeowners may find their monthly mortgage payments increase if they refinance with a higher interest rate. This increase in cost can get passed onto the new buyer. If housing prices are already high, buyers may consider putting in less competitive offers or staying out of the market altogether.

This could cause a decrease in buyer demand and soften the housing market.

However, if there is a rise in interest rates gradually, it would give buyers time to adjust to the new cost of borrowing. If this occurs, it will not immediately affect demand for homes and drive down real estate prices.

Overall, rising interest rates will decrease demand for homes in Toronto, where home prices are already high. If the increase is gradual, it will give buyers time to adjust. However, if interest rates increase quickly, the housing market could receive a shock that softens prices.

What Factors Affect Mortgage Rates?

Inflation, unemployment rates and Bank of Canada activities are amongst the factors that affect mortgage interest rates. However, these factors can take months or even years to affect the market as they gradually change.

It is difficult to predict what will happen with mortgage rates in the future. Even though Bank of Canada policies may lead you to think that they are on track for an increase, there’s no guarantee as global economic factors beyond the government’s control could alter this forecast too. For example, an unplanned economic shock could force interest rates lower.

Bottom Line

Overall, the low mortgage rates in Toronto have been a contributor to rising real estate prices. Although it is difficult to predict how rising mortgage rates will affect the city, it will likely influence real estate demand. However, interest rate increases are typically gradual, which should give the market enough time to adjust.

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