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Mortgage rates are rising as the Bank of Canada tightens monetary policy to combat inflation. When borrowing costs rise, housing demand falls and house prices decline. The question is, just how low could house prices go?

Prospective buyers and homeowners alike have a stake in the answer, as home ownership accounts for a significant portion of Canadians’ wealth — about 40% to 60% of total assets depending on age.

The average home price was roughly $630,000 in July, down 5% from about $663,000 in July of last year, according to data from the Canadian Real Estate Association (CREA).

While the aggregate composite MLS home price index was still up nearly 11% on a year-over-year basis in July, the index was down significantly from the near-30% year-over-year increases earlier this year, CREA noted on its website.

In a recent report, Scotiabank Economics tackled the question of whether home prices would continue to decline as rates rise, and by how much.

Scotiabank modelled home prices based on different fixed five-year mortgage rates through 2023 ranging from 3.20% — the 2021 low for five-year fixed mortgages — to 7.0% and including projected yields of the five-year Government of Canada bond. (Yield on the five-year bond is a benchmark for fixed mortgage rates and Scotiabank’s choice for its base case.) The model assessed mortgage rates’ impact on housing activity by measuring residential investment.

Results showed that the higher the mortgage rate, the larger the percentage change in home prices from their peak in Q1 compared to the end of 2023. However, prices remained above their pre-pandemic levels. In March 2020 the average national home price was about $544,000.

The sole exception to prices remaining above pre-pandemic levels was when a 7% mortgage rate was modelled — an unlikely scenario given the current level of mortgage rates and forecasted inflation and policy rates, Scotiabank said.

In its base case scenario, with mortgage rates following five-year bond yields (projected to peak at 5.7% in the fourth quarter), home prices declined by about 23% by the end of 2023 from their peak earlier this year, and were more than 11% higher than their pre-pandemic peak, the report said.

CREA has forecasted that the national average home price will rise by 10.8% on an annual basis to $762,386 by the end of 2022 and hit $786,252 in 2023.

But other economists are anticipating price reductions in line with Scotiabank’s model.

In June a trio of Desjardins economists said they expected the average national home price to fall by 15% between its February high — $817,253 — and the end of 2023, but because “we’re almost there,” they adjusted their forecast in August to predict a drop between 20% and 25%.

“Home prices continue to fall and have further to go before they find a bottom,” said Randall Bartlett, Helene Begin and Marc Desormeaux, in a report released July 11.

“That said, we still believe home prices will end 2023 above pre-pandemic levels nationally and in all 10 provinces.”

In anticipation of a drop in prices, agents have noticed prospective buyers sitting on the sidelines in recent months, while sellers come to terms with the fact that their homes won’t fetch as much money as they would have at the start of the year.

Lori Fralic calls it a “stalemate.”

“We are seeing lowball offers,” said the Vancouver agent with Keller Williams Realty VanCentral.

“There’s lots of bargain hunters out there who are throwing out offers, but if they don’t have to sell, a lot of sellers are saying, ‘No, sorry, not taking it.”’

It’s a change from the torrid pace of sales and frenzied bidding wars seen earlier in the year and late last year.

With some economists projecting a potential 50-basis-point hike by the Bank of Canada on Sept. 7, people who don’t need to buy immediately may want to hold off — though don’t expect prices in cities like Vancouver to plummet, Fralic said.

Even without tighter monetary policy, Scotiabank Economics said its modelling showed that home prices were set to decline, reflecting worsening economic conditions such as loss of purchasing power and the fall in stock markets.

As such, monetary policy has the ability to fight inflation with “heightened efficiency” in the current environment, it said.