Bank of Canada Rate Cut: How It Alters The Housing Market

It happened. The Bank of Canada finally lowered its overnight rate. It was a characteristically cautious reduction — 5% to 4.75% — but as the Bank’s first rate cut in over four years, it brings with it a certain sense of cloud-parting.

“With continued evidence that underlying inflation is easing, Governing Council agreed that monetary policy no longer needs to be as restrictive and reduced the policy interest rate by 25 basis points,” the Bank of Canada stated in a press release.

A lower overnight rate means most lenders will be rolling out slightly lower prime rates in the next 24 hours. Expect softer variable rates on personal loans, certain credit cards and the two-trillion-dollar elephant in the room, mortgages.

What will a modest reduction in variable rates mean for the housing market? We won’t really know until there’s a few months’ worth of data to chew on, but here are the likeliest scenarios.

Minor relief for debt-laden homeowners

One positive effect of the Bank’s rate cut will be a lighter burden on homeowners struggling with variable-rate mortgage or home equity line of credit debt.

Homeowners who took out variable-rate mortgages when rates were at historic lows during the COVID-19 pandemic have been hammered by rising interest costs since the Bank of Canada started increasing the overnight rate in March of 2022.

The Bank’s series of hikes ultimately added 475 basis points to variable mortgage rates. A rate of 2.25% in January 2021 rose to 7% by July of 2023. Over that period, the monthly payment on a $300,000 mortgage would have ballooned by almost $800.

Even if the majority of homeowners swapped a variable-rate mortgage for a more stable fixed rate before variables peaked, Canadians still owe more than $200 billion in HELOC balances that grew more suffocating with each rate hike.

Managing a HELOC, mortgage payment and daily expenses during a time of elevated inflation has been brutal for Canadian households.

For those feeling crushed by variable-rate debt, the amount of relief resulting from this rate cut will be limited. That’s especially true if they’ve racked up additional credit card debt to make ends meet.

It will take another three or four rate cuts before households are sure the light at the end of the tunnel isn’t a train. That might not happen until 2025.

The housing market: Game on?

Practically speaking, a 25-basis point reduction in variable mortgage rates means almost nothing for home buyers. If variable mortgage rates decline from 7% to 6.75%, they’re still more than two percent higher than the lowest five-year fixed rate available at the time of this writing.

If fixed rates remain static, it could take up to eight rate cuts for variables to become the cheaper option. Opting for a variable at 6.8% also means passing a mortgage stress test at a minimum qualifying rate of 8.8% versus 7% for less for a fixed rate.

Home buyers have had comparatively affordable fixed-rate options available to them all year, and the housing market has still struggled to generate any kind of heat. Slightly lower variable rates don’t remove the barriers keeping people from the market. High housing prices, the stress test and depleted down payment savings remain in full effect.

The FOMO effect

But that was practically speaking. This is the Canadian housing market, so we should probably spend a little time discussing the impractical.

There is a chance that home buyers waiting patiently for rates to fall will see the Bank of Canada’s rate announcement as a signal that buying power is about to improve for everyone. If you listen carefully, you can probably hear their FOMO alarms going off.

The market feeds on buyer perception; if they decide it’s game on, it’s game on. But if hopeful home buyers flood lenders and mortgage brokers with inquiries in the coming weeks, they’ll still run face-first into an important fact: The overnight rate only impacts variable mortgage rates. If a buyer couldn’t get qualified for a much lower fixed-rate mortgage last week, that’s still the case today.

It’s not impossible, but fairly unrealistic, that some buyers who can pass a nearly 9% stress test will opt for variable rate mortgages in the next few weeks. If they’re betting that variables will fall rapidly and save them a pile of money, they need to know that the Bank of Canada isn’t likely to cut the overnight rate fast enough to make these bets pay off.

They’ll learn that from their mortgage advisors soon enough.

The takeaway

A minor rate cut from the Bank of Canada is more “meh” than “hallelujah” where housing is concerned. It’ll make things a little easier for indebted households, but it won’t change the game for buyers.

And that’s fine. The last thing the Canadian real estate market needs is another low rate-triggered feeding frenzy. The Bank of Canada knows this, so expect minimal rate cuts to be the norm going forward.

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