It's all about interest rates

Pretty much since the first day this blog started, the fundamental theme has been that the one element that will prick the massive housing bubble being blown in our little hamlet in the Village on the Edge of the Rainforest is interest rates.

Interest rates have been artificially suppressed by the powers that be since the dot com crash after 1999.

All around the world this factor has contributed to a real estate boom.

Here in Canada, cheaper access to mortgage funds combined with an easing of mortgage credit terms have created the liquidity that homebuyers have used to drive the price of real estate skyward.

When interest rates reset to the historic norm (8.25% over the past 20 years), the housing bubble will pop in spectacular fashion.

Today Capital Economics has come out with a bleak report suggesting that the Canadian housing market is likely to suffer the same sort of crash that has plagued countries such as the United States.

The catalyst?

Interest rates, of course.

In an article in today's Globe and Mail newspaper the headline screams, rate hikes could spark house price collapse

According to economist David Madani, “even small rises in official interest rates have been shown to have a big effect on homeowner confidence in other countries under similar circumstances as they can change perceptions towards the housing market very quickly. If the Bank of Canada does resume its monetary tightening this year, this could easily prove to be a tipping point for a house price collapse.”

This is no great surprise. The problem is NO ONE believes interest rates will ever return to those historic norms.

That's why we get ridiculous surveys like the one released by the Canadian Association of Mortgage Professionals last year showing that Canadians are confident they can shoulder higher mortgage payments without too much difficulty, with 84% saying a $300 monthly increase was no problem.

That's because no one evisions any sort of dramatic hike in rates.

Using the CMHC mortgage calculator for a $550,000 mortgage, the current monthly payment amortized over 35 years at 3.75% is $2,377.79.

Hike that rate to the historic 20 year norm of 8.25% and drop the amortization to 30 years (as per the new rule changes for mortgages) and the monthly payment on renewal jumps to $4,078.61.

How many households can handle a $1,700 jump in monthly payments?

Even if the rate only rises to 6%, the monthly payment jumps by almost $900... triple the $300 per month jump the survey says most Canadians can handle.

Capital Economics predicts that "as the central bank raises interest rates, mortgages will become more expensive for Canadians. Add inflation to the mix and prices could fall 25%-35% over the next few years."

The domino effect of a drop far smaller is what triggered the collapse in the United States. Combine this with the fact that our home prices are severely out of whack with elements such as incomes and the cost of renting and you have the recipe for a massive collapse here in Vancouver.

The elephant in the room is interest rates. And many Canadians are in denial that they will ever be allowed to rise above 5% again.

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Email: village_whisperer@live.ca

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