The Canadian housing market is entering a phase that may very well be confusing for first-time home buyers. We are suddenly in an environment in which interest rates are on the rise and the hot housing market is cooling off. Should buyers jump into the market before rates march further upward or should they wait for housing prices to decline?

In the first quarter of 2010, housing prices were setting record levels around the country and sellers still had the upper hand over buyers, with bidding wars erupting in some markets. There were a number of factors driving the boom. New mortgage rules, scheduled to take effect April 19, that raised the threshold for qualification drove some buyers into the market. Others rushed in to beat the effect of the coming HST on new homes in Ontario and British Columbia. The anticipation of higher mortgage rates also encouraged some to leap in and secure lower rate mortgages.

Now that many of those buyers have bought their homes and the Bank of Canada has started hiking rates, the housing market is slowing down, perhaps faster than anticipated.

On Tuesday, the Canada Mortgage and Housing Corp. announced that the country’s new housing market is showing signs of cooling down, as housing starts declined unexpectedly to 189,100 units in May from a revised 201,800 units in April. Economists polled by Bloomberg had expected the pace of housing starts would be 202,000 units in May.

It is expected that the resale home market will also show signs of slowing when the Canadian Real Estate Association (CREA) releases its report on May activity next week.

“I’m one of those that have been saying the market will cool in the second half – and the reports we’re seeing suggested it’s already started,” says Will Dunning, chief economist for the Canadian Association of Accredited Mortgage Professionals (CAAMP). He expects the CREA report on resale activity to show at least a 10-per-cent decline compared with the prior month.

What is difficult to determine is how quickly and dramatically housing prices will decline. One key factor will be the trajectory of interest rates over the next several months.

On Monday, the National Bank of Canada warned of the significant effect rising interest rates will have on the residential housing market.

“The residential real estate sector, which is extremely sensitive to interest rate fluctuations, could have the wind knocked out of its sails if interest rates do nothing more than normalize,” economists Matthieu Arseneau and Yanick Desnoyers said in a report.

For first-time home buyers in particular, trying to strike a balance between the prospect of higher mortgage rates and lower home prices is daunting.

“If you’re feeling pressure to time the market, the pressure might be less than you’re thinking,” Mr. Dunning says. He expects the Bank of Canada to raise rates two to three times this year, but not aggressively so, given the state of the world economy.

“You can drive yourself crazy trying to do the calculations between interest rates and housing prices. It’s not possible to time the housing market successfully. You won’t have more success timing the housing market than the stock market. You won’t be successful in anticipating changes in interest rates either.”

Mr. Dunning counsels home buyers to base their purchasing decision not on the investment attributes of a house, but on their personal circumstances. What really matters is how you’re positioned with your job, he says. Do you feel secure in your job? Do you expect your income to rise? Your level of confidence in your personal financial situation should be the most important factor in your home buying decision, not macro-economic conditions.

He also cautions buyers to stick with their budgets and those in variable rate mortgages should give themselves plenty of room in case interest rates rise. “Pay what you think you can afford to pay,” he says. “In the heat of the moment, you might find that you can be comfortable paying up to 15 per cent more than you had been planning, but it gets dangerous beyond there.”