Canadian real estate markets have just suffered a shock, but another is on the way. BMO recently told investors they expect mortgage pre-approvals to support markets. Much of today’s home sales do not reflect current mortgage rates, as many secured their interest charges months ago. The erosion of purchasing power will deliver another shock in the coming months, the bank warned.
Canadian real estate mortgage pre-approvals and market
When a borrower applies for a mortgage, they get what is called a pre-approval. These allow the borrower to get a rate while shopping for a home. Typically, this gives buyers 90 to 120 days of interest rate protection. It’s much more convenient for buyers not to see their buying power fluctuate from day to day.
It’s odd that interest rates are climbing so fast, making it a weird situation. Data from mortgage comparison site Ratehub shows the average 5-year fixed rate was 3.59% in June. This means those borrowers with pre-approval have until October to purchase at their guaranteed rate. A borrower in this situation receives a discount of almost 1 point and a limited time to use it.
Canadian home buyers are still motivated by pre-approvals
BMO argues that this creates a sort of buying cliff, where sales are still driven at lower rates. Buyers with pre-approvals wonder if their interest costs will go up more than prices will go down. Home prices are falling, but they could fall even faster without prior approval. When there is an expiration date on your mortgage, you may place more emphasis on timeliness than value.
“Right now it’s a bit of a unique situation where many potential buyers have pre-approvals in hand ahead of the big BoC tightening wave, while also looking at 10%-20% discounts on house prices,” said Robert Kavcic, senior economist at the bank.
He adds: “If you can buy at a discount with a mortgage rate that no longer exists, that might be attractive.”
A “huge” shock still awaits Canadian real estate
Current buyers do not fully reflect the impact of financing on liquidity. As a result, BMO told investors they expected another shock, using Ontario to illustrate its point.
“…the big picture is that there is still a huge interest rate shock to absorb. From an affordability perspective, the year-over-year increase in the cost of owning an average home purchase in Ontario was not matched until the late 1980s (and that factors in already lower prices ),” Kavcic explained.
This point could be crystal clear to the industry. However, he clarifies for the average person: “In other words, this is the most significant tightening of housing conditions in a generation, and it will come with further adjustments…”