With rates on the rise, how low can home prices go?

Mortgage rates are rising as the Bank of Canada tightens monetary policy to combat inflation. When borrowing costs rise, housing demand falls and house prices decline. The question is, just how low could house prices go?

Prospective buyers and homeowners alike have a stake in the answer, as home ownership accounts for a significant portion of Canadians’ wealth — about 40% to 60% of total assets depending on age.

The average home price was roughly $630,000 in July, down 5% from about $663,000 in July of last year, according to data from the Canadian Real Estate Association (CREA).

While the aggregate composite MLS home price index was still up nearly 11% on a year-over-year basis in July, the index was down significantly from the near-30% year-over-year increases earlier this year, CREA noted on its website.

In a recent report, Scotiabank Economics tackled the question of whether home prices would continue to decline as rates rise, and by how much.

Scotiabank modelled home prices based on different fixed five-year mortgage rates through 2023 ranging from 3.20% — the 2021 low for five-year fixed mortgages — to 7.0% and including projected yields of the five-year Government of Canada bond. (Yield on the five-year bond is a benchmark for fixed mortgage rates and Scotiabank’s choice for its base case.) The model assessed mortgage rates’ impact on housing activity by measuring residential investment.

Results showed that the higher the mortgage rate, the larger the percentage change in home prices from their peak in Q1 compared to the end of 2023. However, prices remained above their pre-pandemic levels. In March 2020 the average national home price was about $544,000.

The sole exception to prices remaining above pre-pandemic levels was when a 7% mortgage rate was modelled — an unlikely scenario given the current level of mortgage rates and forecasted inflation and policy rates, Scotiabank said.

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