If you’re currently in the market as a first-time homebuyer, want to buy a bigger home or perhaps need to renew your mortgage chances are you’re paying close attention to mortgage interest rates. Close enough to know that the Bank of Canada just increased its overnight rate, again. This means even higher variable mortgage rates and further erosion of home affordability. And don’t think you can escape this budgetary erosion with a fixed-rate mortgage, as these rates follow government bond yields, which are currently at a seven-year high prompting big banks to incrementally increase fixed-term mortgage rates, as well. This leaves home buyers wondering how much home they can actually afford?
The question, then, is with rising rates and building inventory — and some markets already experiencing price drops — should potential home buyers and those in the market to renew a mortgage hold off and wait or lock-in now?
To help make this decision, it’s important to understand how mortgage rate increases impact monthly housing costs. (To see the full impact, see our article on the impact of rising rates on your budget.)
Take, for instance, a first-time home buyer with a monthly housing budget of $2,500 and a 20% down payment. Last year, this buyer could afford to purchase a home for as much as $633,000 (assuming a competitive 3% fixed 5-year term on a 25-year amortization). Fast forward 12 months to November 2018, and this same home buyer is now faced with 5-year fixed rates of 3.9%. This mortgage interest rate increase will force them to drop their maximum home purchase price by almost $65,000, to $568,300. In just one year, that homeowner’s purchasing power dropped by 11.4%.
Now, what if rates rise beyond 3.9%. What if mortgage interest rates rise to 5% or even 6%. To keep the monthly housing costs at $3,500, that same buyer would have to drop their house purchase price. In higher-priced markets, like Toronto and Vancouver, a drop in the purchase price can also mean a change in the type of property you buy.
For instance, that buyer who waited until mortgage rates hit 5%, she had to drop her house budget by 23%, to just over $513,000. If she waited until rates were 6% rates, she’d have to drop her house budget by more than a third (36%) to $465,620. At this point, she may no longer find a single-family home or even a townhouse in this price range.
Mortgage interest rates will continue to rise into 2019
Here’s the thing: Rates are expected to continue rising right into 2019. Bank of Canada Governor, Stephen Poloz, recently stated that consumers and businesses should get comfortable with the idea of a BoC benchmark rate closer to 2.5% or even 3.5%. Those rate increases will continuously alter how much home buyers can afford.
At present, the central bank’s benchmark rate sits at 1.75% (up from a low of 0.5% that was last seen in May 2010). Worse, these predicted rate increases may not be gradual. According to industry experts, such as Steve Huebl, a finance journalist who writes for Canadianmortgagetrends.com, “The BoC said the pace of those hikes will depend on “how the economy is adjusting to higher interest rates, given the elevated level of household debt,” as well as global trade policy developments.” In other words, BoC rate increases will come quickly if the economy will allow it. Since the BoC’s benchmark rate dictates what big banks and mortgage lenders charge for variable mortgage interest rates, we need to heed these predictions.
But how does that get us to interest rates closer to 5%? Historically, the most competitive variable mortgage rates were about 200 basis points above the BoC benchmark rate — add this to the prediction made by Governor Poloz and, quite quickly, homeowners will be faced with variable rates in the range of 4.5% and 5.5%. Those looking for a bit of security by locking into a fixed rate will need to add on a few more basis points — historically fixed rates are 100 to 150 basis points higher than variable rates — putting the price for a bit of mortgage rate security closer to 5.5% to 7.0%.
It’s not just housing affordability that is impacted
As rates rise, this will have an immediate and direct effect on the number and type of homes a buyer is able to afford.
A home buyer in Langley, B.C. would experience a 50% drop in the number of houses that fit their budget and criteria with a mortgage rate increase of just 0.75%.
For example, say you’re a potential buyer with a 20% down payment saved up. You’re looking for a three-bedroom, two bathroom home in Langley, B.C. and, after crunching the numbers, you and your spouse settle on a monthly housing budget (what you can spend on either rent or mortgage) of no more than $3,500 per month. Based on this budget, an increase in mortgage rates from 3.25% to 4% would reduce the number of houses you can afford by 50%, although there would only be a small reduction in the number of townhouses and condos in this price bracket. (For those curious, initially, there would be 66 houses, 170 townhomes and 22 condos available after the rate increase there would be only 33 houses, 166 townhouses and 22 condos available in that price band.)
Plenty of multi-family options are still available to these buyers, but the number of single-family homes that fit their needs and budget has been cut in half.
Why? Because at 3.25% your maximum house purchase price would be close to just under $862,000, but add in the 75 basis point increase and that maximum house purchase price drops to $795,700.
A buyer looking in Metro Toronto’s east end would face a similar problem. At 3.25%, a buyer would have 21 single-family houses, 3 townhomes and 2 condos to choose from within their parameters (three-bedroom, two-bathroom under $862,000). Increase that variable rate mortgage to 4% — with a maximum purchase price of $795,700 — and there are only 14 houses, 2 townhomes and 2 condos to choose from, based on their housing needs.
What does this mean?
Those looking to buy will really need to get a firm grasp on their finances. Why? Because how big your down payment is, still matters.
For instance, if you bought now with only 5% down and secured a rate at 3.5%, you could afford a home priced just under $724,000 (to keep your monthly mortgage payment at $3,500). And this is taking CMHC fees into consideration. Now, if you waited to save up 20% for a down payment, you could risk rates going up. Let’s assume rates reach 5%, at this point the maximum home you could purchase would be closer to $718,000. Not much of a difference, right? The problem is most people don’t shop for a home based on monthly budgets — although they really should! Instead, most people calculate the maximum house they can afford based on mortgage pre-approval calculators.
Now, let’s assume as a buyer you have 5% down and a maximum house budget of $850,000. If you bought now and got a mortgage interest rate of 3.5% then your monthly mortgage payment would be close to $4,250 (even taking into consideration CMHC fees that are added on to your total mortgage debt).
If you were to wait a year and save up 20% but your mortgage interest rate went up to 5%, that $850,000 home would $3,975 per month in mortgage payments. The question, then, is whether or not waiting a year and risking rates rising is worth the $275 per month in savings.
To help you decide, we’ve calculated the maximum house you can afford based on the mortgage interest rate you get and the monthly mortgage payment you can afford. To keep it an even playing field, we added in the CMHC fees into the total house price for the 5%, 10% and 15% down payment charts. This means that your actual house price would have to be lower, to accommodate for those fees.
At 5%, here’s how much home you could afford:
At 20%, here’s how much home you could afford:
Home Owners Looking to Renew
If you’re already a property owner, the rising rates will impact you in other ways. While the erosion of purchasing power from rising rates won’t impact you directly, (unless you’re in the market to sell) rising rates will still put a pinch on your monthly budget, particularly if you carry debt. (Read more on how rising rates will impact your household budget.)
For those facing a mortgage renewal in the next 12 or so months, you may need to consider whether or not paying a penalty to break the mortgage contract and lock-in to rates now would be worth it. That’s because any rate hike will definitely impact what you pay per month.
For example, if you have $350,000 left on your mortgage, breaking your mortgage and locking in at a five-year rate of 3.9% would put your monthly mortgage payments at around $2,103 (if you renewed with a 20-year amortization). However, if you risk it and wait for another 12 months when mortgage interest rates could rise another 75 basis points (that would be three increases 0f 0.25%) and you could end up paying $2,243 per month on that newly renewed mortgage. Waiting that one year would end up costing you an extra $8,400 over the next five years (assuming you lock-in to a five-year fixed mortgage rate).
Renew your mortgage now and you could save as much as $8,400 over the next five years.
So, should you break your current mortgage and renew? To determine this you’ll need to break out the pencil, paper and calculator.
First, determine how much it will cost you to break your mortgage contract. For variable mortgage rates, the penalty is the equivalent of three months of mortgage interest. For fixed mortgage rates, the penalty is based on a calculation known as the Interest Rate Differential (IRD). This calculation is different for every bank and lender, so it’s best to call and ask what it would cost you to break your mortgage, as of today. Now, take the penalty cost and subtract it from the possible savings over the next five years. If you save money then it may be worth it to renew now rather than wait. (Keep in mind, what you are currently paying in monthly mortgage payments. If it’s significantly lower, you may save money sticking with your current mortgage and renewing at the higher rate, again, a quick calculation can help you decide.