Why Lower Interest Rates Might Make Housing More Unaffordable: Bank of Canada Research

Why Lower Interest Rates Might Make Housing More Unaffordable: The Hidden Truth from Bank of Canada Research

The Counterintuitive Finding

Bank of Canada staff recently released a study with a conclusion that surprised many homebuyers:

Lower interest rates may reduce your monthly mortgage cost, but they are unlikely to improve housing affordability. In some cases, they could actually make homes more expensive.

This seems counterintuitive at first. After all, lower rates mean less interest paid on your loan and higher purchasing power — which should make buying a home easier, right?

But the Bank of Canada study used historical data to reveal a deeper market mechanism: when interest rates fall, what changes first in the market is not more houses being built, but buyers coming back.

The Timing Gap: Purchasing Power Moves Faster Than Supply

The Bank of Canada study examined how secondary market transactions, new housing starts, and home prices respond to unexpected monetary policy easing.

It revealed a critical timing gap:

Buyers’ purchasing power can change in a very short period.

Consider a household with unchanged income and savings. If the interest rate drops from 7% to 6.5%, the monthly interest payment decreases. The borrowing capacity calculated by banks also increases. Someone who could previously afford a $700,000 home might now look at $750,000; those who had temporarily exited the market may return.

But housing supply cannot suddenly increase within the same few months.

A new home goes through planning, approval, financing, and construction before it truly enters the market. The Bank of Canada study found that while new housing starts are eventually stimulated by lower rates, significant increases take approximately two years to materialize.

This is the most critical part of the story: buyers’ purchasing power strengthens first, while housing supply follows later. When more purchasing power chases a relatively unchanged housing supply in the short term, the result tends to shift from “mortgages are cheaper” to “people are bidding higher.”

Home Price Response Lasts Longer Than Supply Response

The study’s data shows that after interest rate declines, the upward pressure on home prices persists for a relatively long time. Even when lower rates eventually stimulate developers to increase construction, the force of increased demand still exceeds the force of increased supply.

In other words:

• In the short term after a rate cut, buyers flood in and push up prices

• After two years, new housing supply increases, but demand has already been front-loaded

• The end result is often home prices staying at elevated levels

So when many people wait for lower rates before buying, the question they most often overlook is this: you are not really buying interest rates. You are buying homes.

If a slightly lower mortgage rate saves you some monthly interest, that is real money in your pocket. But if at the same time many buyers gain higher borrowing capacity due to rate cuts and home prices rise accordingly, the financing cost you save can easily be eaten away by the higher purchase price.

The Economic Environment Determines How Rate Cuts Work

The study had another particularly important finding: the same rate cut can have completely different effects on the housing market depending on the economic environment.

When unemployment is relatively high, even lower interest rates may not make people feel confident enough to buy homes. People worried about job loss will hold more cash. Banks may tighten lending standards during weak economic periods. And some families, despite seeing lower rates, cannot pass mortgage qualification tests due to income instability.

So cheap money sitting there does not guarantee anyone will borrow.

But when unemployment is low and jobs are stable, the situation changes completely. Families feel more confident about future income, and bank credit transmission works more smoothly. Buyers who had been waiting can re-enter the market more easily once rates drop.

The study found that in low-unemployment environments, the impact of rate cuts on secondary market transactions, new housing starts, and home prices is all significantly stronger.

This creates a third layer of complexity: many people think that good economic conditions, stable employment, plus lower rates must be the most comfortable time to buy a home. For an individual household, this may indeed be true. But if thousands of households receive the same signal simultaneously, the market outcome could be completely different.

Everyone has stable jobs, everyone gains borrowing capacity, and everyone starts looking at homes at the same time. But housing supply does not increase simultaneously. What looks like “improved buying conditions” for individuals, when aggregated, may become renewed upward pressure on market-wide home prices.

Do Not Misinterpret the Study as “The Bank Cannot Cut Rates”

However, it is important not to interpret this study as meaning the Bank of Canada should never cut rates again, or that every future rate cut will cause home prices to surge.

First, this is a study by Bank of Canada staff, not an official forecast from the Bank’s Governing Council on future interest rates or home prices.

Second, it examines historical monetary policy shocks, primarily using data from before 2019. Canada’s current demographic changes, construction costs, approval timelines, and housing market structure may all differ from the past.

Furthermore, the study authors themselves caution that they present results for 25 basis point policy shocks. You cannot simply multiply this result by several to predict what a much larger rate cut would cause.

One more important point: the Bank of Canada’s core mandate for adjusting interest rates is controlling inflation, not targeting a specific level of home prices.

What This Means for Ordinary Buyers

That said, the contradiction this study uncovers is very worth noting for ordinary homebuyers. If Canada’s fundamental housing problem is that demand consistently exceeds supply, then relying solely on interest rates cannot solve this imbalance.

High interest rates can suppress some buyers, but at the cost of higher monthly payments and tighter financing. Low interest rates can reduce borrowing costs, but if housing supply does not increase faster, they may simply amplify buying demand.

So what truly changes long-term housing affordability are the hardest questions: land, approval processes, infrastructure, construction costs, and whether homes can be built faster.

The Bank of Canada staff’s conclusion was clear: when housing is already in a state of supply shortage, monetary policy is not the most appropriate tool to address this supply-demand imbalance.

Two Calculations Buyers Should Make Before Purchasing

What does this mean for ordinary buyers? Do not base your entire home-buying plan on “waiting for the next rate cut.”

There are two calculations you should really make:

First, how much will your actual monthly payment decrease when rates drop?

Second, if the rate cut brings more buyers back into the market, will the type of home you are looking at also become more expensive?

Making only the first calculation and ignoring the second often leads to an awkward outcome: you finally got the cheaper loan you waited for, but you did not get the cheaper home.

What do you think Canada’s housing market is missing most right now: lower interest rates or more homes? Share your thoughts in the comments below.