The low interest rate trap: How cheap money fizzled as home prices soared
Low interest rates helped Canadians get into the housing market — and then pushed prices beyond their reach
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Paul Smetanin has a wake-up call for younger Vancouver and Toronto residents who have been told for years that they should take advantage of historically low interest rates and get into the real estate market.
“That was the right advice between 2000 and 2005,” said Paul Smetanin, president of the Canadian Centre for Economic Analysis.
“But after 2007 you essentially had investors coming into the market and squeezing out households.
“It comes to a point where the lowness of interest rates doesn’t matter anymore because the prices of homes went up so quickly, and by so much, that resident households can’t take advantage of low interest rates.”
In the wake of the 2008 financial crisis, central banks lowered interest rates as a tool to encourage investment and stimulate hard-hit economies. While the U.S. Federal Reserve has started to gradually raise rates, the Bank of Canada has moved in the opposite direction in response to the oil price plunge of 2014.
Canada’s economy continues to struggle against slow economic growth globally, and Stephen Poloz, governor of the Bank of Canada, has signalled interest rates will likely stay low for some time.
While low interest rates stimulate a sluggish economy, they’ve had an unwanted effect on the overheated real estate markets of Vancouver and Toronto. In June the bank warned mortgage payments compared to incomes have been growing in those cities, as have loans with longer amortization payments, which reduce monthly payments but put borrowers deeper in debt.
At the beginning of the 2000s, lower interest rates made it possible for lower-income households to compete with wealthier people to bid for homes, Smetanin said. But they were gradually edged out by both local and foreign investors who also took advantage of cheap money.
“Homes started to be viewed as a commodity,” Smetanin said.
It’s people under 45 who have really lost out in this scenario, as home price inflation in Vancouver and Toronto has now pushed home ownership out of reach, Smetanin said.
That’s led Paul Kershaw, a University of British Columbia professor who started an advocacy group called Generation Squeeze, to wonder if interest rates for housing should be somehow different than for the rest of the economy.
“I can’t understand why we couldn’t think about having a general approach to lending, but then have a more specified approach to the way we’re lending in regards real estate,” said Kershaw, who argues current taxation and policy is set up to support older Canadians while leaving younger people to struggle.
“We’re stuck in this world where we’re just going to continue to have low interest rates fuelling home price growth, but that’s harmful growth.”
Both Smetanin and Tom Davidoff, a UBC economist who studies real estate, said that idea won’t work: raising interest rates right now across the board would slow Canada’s economy, Davidoff said, while Smetanin pointed out that sophisticated investors would likely find a way around a system that somehow had separate interest rates for different kinds of lending.
Smetanin suggest that governments need to step up their role as “referee” to “monitor and restrict investor behaviour,” while the federal Ministry of Finance could further shorten the amortization period of mortgages.