When Will Interest Rates Return To “Normal”? Low Interest Rates and The Hot Housing Market.

There are many factors that affect the price of housing. Supply, demand, jobs, geography, demographics, advertising, peer pressure, Government regulations (CMHC) and interest rates all affect house prices in their own way. Clearly interest rates have a definite impact on the price of homes. You could speculate that interest rates are the most important factor in the housing market (…at least in Canada).

Although housing markets in other countries have continued to decline, significantly, despite record low interest rates, Canada’s housing market has increased, significantly. Other countries (America, Ireland, Japan…), have had record low interest rates and their housing market continues to lose value. Japan has had near 0% interest rates for more than a decade and their housing market has dropped by 66%. If a declining interest rate environment can cause a dramatic increase in the price of housing, evidence shows that a sustained low interest rate can not stop a housing bubble collapse.

In Canada we have seen more than 10 years without a year over year drop in the average price of a home. This rise in house prices has come at the same time that interest rates have been declining.

The Beginning: 2000 − 2005.

The housing market began to steadily grow between 2000 and 2005. This was long before the financial crisis. From 2000 to 2005, the economies in most countries were is good shape. In 2000, interest rates were slightly lower than the historical average of 8%. However, they began moving lower and this move started the housing market boom.

When the historical average is 8% and potential home buyers saw that they could buy a home at a 7%, 6% or even 5% interest rate, they start buying. “What a deal”. People expected the low interest rate environment to be short lived. “Buy now!” while interest rates are low. Little did they know that low interest rates would become the new “normal” and would last for 8 years (and counting…). However, in hindsight, buying a home between 2000 and 2005 was a smart move. As housing prices were set to take off in Canada. The housing bubble snowball was about to start rolling down the hill and was about to start getting bigger and bigger….

2006 − 2010

The stage was now set for a real housing boom. Interest rates were sitting at 5% in 2006. CMHC was loosening the rules. People began to see a home as a “can’t lose” investment. Peopler were saying “Everyone else is buying a home, so why don’t we”. From 2006 to 2008, it seemed like the banks wanted to make it as easy as possible for someone to buy a home: Prime minus 1% mortgage rates! Prime minus 2% mortgage rates! Buyers had the ability to purchase homes with no money down, 40 year amortizations, and interest rates of 2%. This is like throwing gasoline on a fire. Combine the incredible low interest rates with the cultural phenomenon of a housing bubble and you will have rapidly rising house prices.

Despite an astoundingly short dip in housing prices during the financial crisis, the Canadian Real Estate Housing Market continued to grow from 2006 to 2010. The continued rapid rise in housing prices, over and above the previous, cause a few people to speculate that Canada was entering housing bubble territory.

2011 – ?

Despite 10 years of increasing prices, 2011 has not shown a slow down. Prices are still increasing. In Vancouver and Toronton prices are more than 5% higher than the year before. The number of homes selling has been dropping in 2011. Interest rates increased slightly in 2010, only to drop back down to record lows in 2011.

Lower interest rates make the carrying cost of a home lower. So lower declining interest rates cause home prices to increase. The important question is “Will interest rates increase, and if they will, then when?” Housing bubble predictors have been wrong so far.

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