A Housing Bubble & High Interest Rates Could Lead to a Flood of Financial Difficulties

The Canadian housing market has been a hot topic for many years, with the current pandemic intensifying the crisis. Predictions for the future of housing prices are not optimistic, with an anticipated continuous rise in 2022, and an impending market crash that could potentially trigger a recession.

Understanding Housing Bubbles

A housing bubble occurs when prices in the real estate market soar due to an increase in demand, overspending, and speculation. It usually starts with high demand and limited supply, which naturally cause prices to rise. As people observe these price hikes, they are motivated to invest more in real estate, thereby fueling the demand and maintaining the supply shortage.

The Formation of Housing Bubbles

Housing bubbles begin with the fundamental economic principles of high demand and limited supply. In the case of Canada’s housing market, this high demand is driven by low-interest rates. As people notice rising housing prices, they assume this upward trend will continue indefinitely. This assumption encourages more investment in the market, aiming to gain profit. This cycle is propelled by a psychological phenomenon known as the hot hand fallacy, where individuals believe success will continue based on past performance.

The Bursting of a Housing Bubble

When a housing bubble bursts, the real estate market becomes overvalued, and housing prices plunge sharply. This sudden decrease can lead to negative equity for homeowners, meaning the value of their property is less than the debt they owe against it. This can wreak havoc on an economy as people are left paying for an asset that has lost its value.

The Emergence of the Canadian Housing Bubble

The Canadian housing bubble, particularly in Toronto and Vancouver, has been a long-term issue. Over the past 20 years, home prices in Canada have increased by 375%. For Toronto and Vancouver, the figures are even higher at 450% and 490% respectively.

The Unchecked Growth of the Housing Bubble

Despite the 2008 financial crisis, which was mainly caused by a housing bubble, Canada did not take sufficient measures to control its burgeoning housing bubble. This has left the Canadian housing market vulnerable to a potential housing bubble burst.

Housing Affordability in Canada

With the average cost of a home nearing $800,000, more than half of Canadian households cannot afford to buy a home today. To qualify for a mortgage, many would need to increase their income by 88%, factoring in both the down payment and monthly mortgage payments. This issue predominantly affects younger demographics and single-family households.

The Escalation of Home Equity Line of Credit (HELOC) Debt

HELOC debt in Canada is skyrocketing, reaching $166.8 billion as of October 2021. At the onset of the pandemic, many Canadians began paying down their debts, including HELOCs. However, the reliance on HELOC debt has resurfaced, setting Canadians back to square one.

The Increase in Loans Secured by Housing

Over the past five years, there has been a surge in Canadian loans backed by housing collateral. This suggests a potentially overleveraged national housing market, which could lead to severe consequences if the housing market collapses.

The Influence of Inflation on Home Prices

Inflation, another growing concern for Canadians, is also impacting home prices. While the cost of essentials like food, gas, and utilities is on the rise, the rate of inflation is still lower than the rate of home price growth. This is advantageous for homeowners with mortgages, as the value of their assets is increasing at the rate of inflation or higher.

The Future of the Canadian Housing Market

Unfortunately, the Canadian housing bubble is expected to persist into 2022, with housing prices continuing to rise due to both inflation and the housing bubble. This poses a particular challenge for young homebuyers.

Managing Debt Amidst Economic Instability

With economic instability on the rise, many Canadians may find it increasingly difficult to manage their finances. Whether you are currently in financial trouble or simply seeking advice on debt management, experts at Bankruptcy Canada can assist. Don’t hesitate to reach out for a consultation today.

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