Interest rate hikes to cause a collapse? More like a correction.

Capital Economics made the news last week for their controversial and bleak prediction on the future housing market, which asserted Canadian house prices could fall by 25% in the next few years. The stated principal cause driving this prediction was the prospect of raised interest rates.

Raised interest rates, Capital Economics suggested, would trigger affordability concerns for Canadians holding variable mortgages.

However, the underlying assumption at play is that Canadian mortgage rates will rise, and substantially, in the near future. Our research and knowledge has led us to believe this not necessarily to be true.

At the last interest rate announcement on January 18th, the Bank of Canada did not raise interest rates, keeping the prime rate at 3%. With the next interest rate announcement 22 days away, here`s what the industry experts are saying:

The Bank of Canada`s last Monetary Policy report stated that leaving the overnight rate at 1% leaves “considerable monetary stimulus in place consistent with achieving 2 per cent inflation.” The economy isn`t expected to “return to full capacity and inflation to the 2% target” until the end of 2012.

Rob McLister, editor of Canadian Mortgage Trends, believes this translates to no prime rate increases until July.

While the Canadian Mortgage and Housing Corporation has said “no movement is expected this year on mortgage rates”.

The stricter new mortgage rules, to take effect on March 18th and April 18th, were implemented to curb excessive household debt levels in the current low interest rate environment. According to Scotia Capital analysts, “regulation was the way to go in terms of curbing household appetite for credit as opposed to the Bank of Canada raising interest rates, which they say would be “imprudent” at this time”.

How to interpret

While the historically low interest rates in place now could last until the end of 2012, at some point they will inevitably rise. When this happens, will home owners be able to absorb higher interest payments?

Also keep in mind Flaherty introduced the qualifying rate in 2010, which forces variable mortgage holders to qualify for the higher 5-year fixed mortgage rate. Right now, for instance, you can find 5-year variable rates as low as 2.10%, but the qualifying rate is 5.10%.

Sources:

http://www.bankofcanada.ca/en/mpr/pdf/2011/mprsumjan11.pdfhttp://www.bankofcanada.ca/en/mpr/pdf/2011/mprsumjan11.pdf

http://www.canadianmortgagetrends.com/canadian_mortgage_trends/2011/01/prime-rate-remains-at-3.html#more

http://www.nationalpost.com/Flaherty+tightens+mortgage+rules/4119505/story.html

http://www.calgaryherald.com/business/Mortgage+rates+remain+stable/4226094/story.html