Housing affordability has declined in Canada to its lowest level in two years due higher prices and increased mortgage rates, according to a report released today by Royal Bank RBC Economics.

The report suggests that affordabiltity will continue to erode for the remainder of 2004 and into 2005.

The average posted five-year mortgage rate rose to 6.45% in the second quarter, a level not seen since the end of last year. As such, the RBC Affordability Index -which measures the proportion of pre-tax household income needed to own a home -rose to 31.7% in the second quarter, from 30.1% in the previous quarter.

“Although housing activity continued at a breakneck pace, rising house prices and higher mortgage rates resulted in increased home ownership costs in every region of the country,” RBC economist Carl Gomez said in a news release.

“Affordability will continue to erode over the balance of this year and next, principally due to relatively mild increases in mortgage rates. But this will be tempered by softer price increases, and improving income growth.

Average monthly Canadian ownership costs, were $1,332 in the second quarter, 6.2% higher than the previous quarter. Costs range from a low of $955 in the Atlantic region to a high of $1,735 in British Columbia.

Meanwhile, new housing starts increased 3.2% from the period before to 232,700 annualized units, the strongest quarterly level of residential construction activity since 1990. With an increase of 7.8%, resale activity in major metropolitan markets also remained up.

The report says the strong pace of housing activity was largely driven by the previous quarter’s decline in mortgage rates.

“Consequently, housing sales in the third quarter of 2004, while still at historically high levels, could fall by as much as 10%, reflecting the second-quarter erosion in affordability,” Gomez said.

British Columbia witnessed the biggest deterioration in affordability. It remains the least affordable region to own a home in Canada with an affordability index of 43.1%. Atlantic Canada and Alberta were the most affordable regions with affordability indexes of 26.7% each.