With the news last week that the Bank of Canada increased its prime rate for the third time this year by 0.25 points to 1.75 , many homeowners are wondering how this will impact house prices. Will this just slow down price growth, or cause a significant drop in what is still a hot housing market?

When trying to predict how the prime rate relates to home prices, it's very important to consider the historical data. Even after the increases this year, the prime rate is still incredibly low historically, making the cost of borrowing lower than at almost any other point in the last century. I find many homeowners have recency bias and are focused more on how interest rates compare to last year than how low they have been historically.

This lends to the impression that any increase in mortgage rates means the market will crash, even though this likely won't be the case.

Opportunity to invest

When you look at the high percentage of every mortgage payment that goes to pay down the principal, real estate remains an excellent investment. This isn't the early 1980s when interest rates crested 20 per cent. With rates that high, almost all of a mortgage payment would go towards paying interest, making it difficult to build up equity. With current mortgage rates, the majority of every mortgage payment goes towards the principal, which builds up equity, creating security for homeowners by reducing the amount they owe and also allowing them an opportunity to invest their gains.

A small increase in interest rates won't keep them away from continuing to invest.

This opportunity to invest is seldom considered, but is an important factor in why real estate prices won't be crashing anytime soon. Even with the market slowing down, real estate prices in Toronto have still doubled over the last several years. This has opened up investment opportunities for homeowners to take money out of their mortgage to pay off debt, do a major renovation or invest elsewhere.

One of the most popular investments is, of course, in real estate. Whether buying a second home, an investment property or an apartment for their children while they attend school, the price increases in Toronto have added a new group of buyers to the mix who normally wouldn't be buying real estate. When you add in these new buyers plus other groups like foreign buyers, who account about 2.5 per cent of all home sales, there is more competition and demand for real estate which drives prices higher. All of these new buyers were created by the huge price gains in Toronto real estate over the last decade, and a small increase in interest rates won't keep them away from continuing to invest.

'First-time buyers are much better served when prices stay level'

I've heard some worry that this latest interest rate hike will make it even more difficult for first-time buyers to enter the market. I agree there is a point that higher interest rates mean higher monthly payments, making it very difficult for first-time buyers to pass the new mortgage stress tests. While higher rates make qualifying for a mortgage more difficult in isolation, we need to remember that these higher rates will slow down price growth, and in the end actually make it easier for first-time buyers to make a purchase.