Can Lower Home Prices Offset Higher Mortgage Rates?

Canadian home prices are falling while borrowing costs are rising rapidly. For prospective buyers, this creates a tug-of-war between lower prices and higher mortgage costs: will the market correction make home ownership more affordable, or will rising interest rates negate those gains?

Overall, modest improvement in affordability is possible, but significant gains are unlikely. To see why, it helps to review how we arrived here and to examine how falling prices and rising rates together affect monthly mortgage payments and the broader affordability equation.

Inflation, not interest rates, is the central bank’s primary concern

Since March 2022, the Bank of Canada has been raising its policy rate to slow surging inflation. In June, Canada’s inflation rate reached a 39-year high of 8.1% year-over-year, easing slightly to 7.6% in July but remaining far above the Bank of Canada’s 2% target.

If inflation remains stubborn, central bankers will likely keep raising rates until inflation is under control—regardless of the impact on homeowners and buyers. Inflation therefore drives monetary policy and, by extension, affordability in housing markets.

For perspective, inflation peaked at 12.9% in 1981 and the Bank of Canada’s benchmark rate reached over 20% that year. Even so, as of Sept. 6, 2022, the benchmark rate stood at 2.5%—still much lower than historical peaks, but rising quickly from recent lows.

Source: CBC News

Home prices are correcting sharply

After a prolonged period of low rates and a COVID-era housing boom, the Canadian real estate market moved into a sharp correction. Prices peaked nationally at $816,720 in February 2022 and fell 18.5% to $665,850 by June. By July the national average dropped further to $629,971, nearly 23% below the peak.

This correction exposed over-leveraged owners and speculators—particularly investors who borrowed against existing properties—which led to increased listings and faster price declines. When owners owe more than their property is worth, they may be compelled to sell, which accelerates downward price momentum.

Source: CREA, Steve Saretsky

Mortgage borrowing costs have climbed

As the Bank of Canada raised its policy rate, mortgage rates followed. Canada’s prime rate rose quickly after the BoC’s July 13, 2022 rate increase, pushing variable mortgage rates significantly higher. Between February and July 2022, variable rates (for mortgages with a 10% down payment) rose from 0.9% to 3.5%, while five-year fixed rates moved from about 2.59% to 4.34%, according to Ratehub.ca data.

	5-year fixed rates		5-year variable rates
	With 10% down	With 20% down	With 10% down	With 20% down
February	2.59%	2.79%	0.90%	1.25%
March	3.04%	3.29%	1.15%	1.70%
April	3.59%	3.69%	1.90%	2.20%
May	3.94%	4.04%	1.90%	2.20%
June	4.79%	5.04%	2.50%	2.80%
July	4.34%	4.59%	3.50%	3.85%

Between February and July 2022, variable mortgage rates rose by about 2.6 percentage points—an increase of nearly 300%—while fixed rates climbed roughly 1.8 percentage points, up about 65%.

How falling prices and rising rates affect affordability

To judge affordability, monthly mortgage payments are a key metric. Using national average home prices for February, June and July 2022 and prevailing five-year fixed and variable rates, monthly payment scenarios were calculated for buyers with 10% and 20% down payments.

Month (with average home price)	5-year fixed (10% down)		5-year fixed (20% down)		5-year variable (10% down)		5-year variable (20% down)
	Rate	Payment	Rate	Payment	Rate	Payment	Rate	Payment
February ($816,720)	2.59%	$3,326	2.79%	$3,022	0.90%	$2,736	1.25%	$2,536
June ($665,850)	4.79%	$3,414	5.04%	$3,110	2.50%	$2,685	2.80%	$2,467
July ($629,971)	4.34%	$3,100	4.59%	$2,827	3.50%	$2,838	3.85%	$2,619

From February to June, variable-rate monthly costs improved slightly because falling prices offset higher variable rates. By July, however, higher variable rates outweighed price declines and monthly variable-rate costs rose. Fixed-rate monthly costs worsened between February and June but improved modestly between February and July. Overall, variable rates remained the more cost-effective option in some scenarios, but movement depends on timing and down payment.

	Mortgage costs (Feb to June 2022)		Mortgage costs (Feb to July 2022)
Down payment	5-year fixed	5-year variable	5-year fixed	5-year variable
10%	Up $89 per month	Down $82 per month	Down $255 per month	Up $102 per month
20%	Up $88 per month	Down $70 per month	Down $195 per month	Up $82 per month

The mortgage stress test reduces buying power

The mortgage stress test requires borrowers to qualify at the higher of 5.25% or their contract rate plus two percentage points. With many variable rates around 4% and fixed-rate offers up substantially, qualifying rates used by lenders often work out to around 6% to 7%, depending on the product.

Higher qualifying rates shrink the mortgage amount a household can secure. Industry estimates suggest that every 1% increase in the stress-test qualifying rate reduces mortgage purchasing power by roughly 10%. That means home prices must fall substantially to offset the tightening effect of higher stress-test rates on affordability.

Even if a buyer can comfortably afford the monthly payment at current rates, they may still fail to qualify under the stress test, which is further suppressing demand and placing downward pressure on prices.

What would improve affordability?

The ideal scenario for buyers would be continued price correction paired with falling interest rates, which would reduce monthly mortgage costs and increase qualifying power. Many economists and banks expect the Bank of Canada to hold rates and possibly cut them in 2023 if inflation retreats. That would help affordability, but any improvement is likely to be modest because the underlying imbalance—insufficient new housing supply versus growing demand—remains.

There is also risk the Bank of Canada must keep rates higher for longer if inflation proves persistent. In addition, buyers and investors tend to anticipate rate cuts, so prices could begin to recover ahead of actual rate reductions, making it hard to time a perfect entry.

Prospective buyers who are waiting for an affordability “sweet spot” should consider widening their search by price range and location to increase the likelihood of finding an opportunity. Getting into the market can also hedge against the possibility of a renewed speculative upswing in prices. As with investing, attempting to perfectly time the market is difficult; act when affordability meets your criteria and your mortgage fits comfortably within your budget.

Ultimately, modest improvement in affordability is feasible as prices fall and rates stabilize or come down, but substantial relief will likely require meaningful increases in housing supply and a return of inflation toward target.