Owning a home becoming less affordable

Home ownership has become less affordable for the average Canadian, but that hasn't stopped many from jumping into what may already be an overpriced market, suggests a new report from the Royal Bank.

Royal Bank says its housing affordability index reversed course in the second quarter of this year in two of the three categories it measures — bungalows and two-storey homes — after generally improving over the past year.

That means that on average, Canadians were paying more of the pre-tax income to service their homes compared to the first quarter of the year, although the index is still down from a year ago.

The quarterly increase was not spectacular — 0.3 points to 42.7 per cent on a detached bungalow and 0.4 points to 48.4 per cent on a standard two-storey home. The index on a condo was unchanged at 27.9 per cent.

"First if you look at detached homes or two-storey homes relative to the condos, you’re finding affordability drops there. It’s more affordable for condos than it is for detached homes," says RBC chief economist Craig Wright, author of the report.

He says affordability has been flat-lined over the past few years as low rates help offset rising prices, but with mortgage rates rising, Canadians could face even more difficulty affording a home. 

"Affordability in the third quarter is probably going to deteriorate, but we have to keep in mind that rates start to rise typically when the economy is recovering and then you get the offset in incomes and prices we think will be sort of flat on a year-to-year basis," Wright told CBC News.

As with past samplings, Vancouver and Toronto continue to stand out as the least affordable cities. During the second quarter, Vancouver's affordability reading rose 2.2 points to 82.1 on a detached bungalow, while Toronto's edged up half a point to 54.5.

Wright says British Columbia has been an "outlier" as the least affordable market since the late 1980s. It's a "significant challenge" affording a home in Vancouver, but housing is more affordable in other parts of the country.

By contrast, other major municipalities were far more tame and below the national average. On a detached bungalow, Montreal slid slightly to 38.1 per cent, Ottawa was mildly higher at 37.1, Edmonton was at 34.0 despite a 1.8 point gain, and Calgary held steady at 33.0.

Sales on the rise

The affordability index measures the cost of servicing a home, including mortgage payments, utilities and taxes, in relation to a household's pre-tax income. The higher the reading, the less affordable is a home to a particular family.

Wright noted that the deterioration in affordability did not scare many Canadians from jumping feet first into the housing market during the second quarter as sales actually surged by 6.4 per cent, following a general slowdown since last summer's introduction of stiffer mortgage lending rules.

"We saw a bit of a bounce-back in prices," said Wright. "We had a series of regulatory changes, but now it looks like the market has adjusted and now seems to be recovering somewhat."

The report is for the April to June period and does not capture this month's announced increases of between 0.1 and 0.2 per cent — 10 or 20 basis points— in posted mortgage rates at several major banks. A 20-basis point hike in rates will increase monthly payments up to $100 on a typical $500,000 mortgage.

"Mortgage rates will be the next challenge," Wright added. "The move upward we've seen probably suggests that affordability will be a little more challenging [in the third quarter]."

But he noted that despite what has been a hot housing market in Canada, with prices hitting new highs almost monthly, affordability remains close to historic levels in part because interest rates are so low.

Central bank warns of rising interest rates

The Bank of Canada has long warned Canadians to take a forward-looking approach to home ownership and calculate what will happen to monthly payments once interest rates begin to rise, which it says is inevitable.

But Wright said the situation of affordability is more complex than simply interest rates. A sharp spike in rates will cause problems, yet most, including the Bank of Canada, currently anticipate the increases will be modest and gradual and won't likely start occurring until late next year. The central bank has kept its short-term trendsetting rate at one per cent for now.

As well, Wright points out that the bank will likely only start a monetary policy tightening phase once the economy starts improving, so the higher rates might be offset by an improvement in employment and in incomes, which could offset the negative impact on household finances. Higher rates might also lead to lower real estate prices, which also improves affordability.