Preparing for higher mortgage rates

If you’re in the market for a new home, you’re probably sweating the headlines. The price of homes is rising, and higher mortgage rates are looming. You’ve read Statistics Canada’s report that national household debt is at a record high. You’ve heard warnings from the Bank of Canada that high consumer debt and imbalances in the housing market are making Canada’s financial system vulnerable. But amid the doom and gloom there’s some good news – housing affordability improved in the third quarter of 2014, according to RBC Economics’ latest Housing Trends and Affordability Report.

“Owning a home was a bit easier in Q3 thanks to rising household incomes, low and steady interest rates and cheaper utility costs in many parts of the country,” says Craig Wright, senior vice-president and chief economist, RBC. “With home resales sitting close to the highest levels since early 2010, the overall tone of Canada’s housing market is quite solid at this stage.”

RBC’s housing affordability index captures the proportion of pre-tax household income required to own and operate a home at current market value. The greater the measure, the worse the affordability. For example, a measure of 50 per cent means owning a home – including mortgage payments, utilities and property taxes – will eat up 50 per cent of a typical household’s pre-tax income.

National affordability in the third quarter fell by 0.2 percentage points to 47.8 per cent for two-storey homes and by 0.3 percentage points to 27.1 per cent for condo apartments.

To put these numbers in perspective, when you’re applying for a mortgage, lenders add up your housing costs and calculate what percentage they are of your gross monthly income, known as your Gross Debt Service ratio (GDS). According to Canada Mortgage and Housing Corp., your GDS should be 32 per cent or less of your pre-tax household monthly income. And with affordability coming in at 27.1 per cent for condos, they’re a great choice.

“A trend that jumped out ... was a further broad improvement in affordability of condos where a strong majority of markets across Canada saw the measure for the segment fall,” Wright notes. “Condos no doubt continue to be the more affordable ownership option in every market.”

RBC attributes the booming housing market to declines in fixed mortgage rates earlier this year, but predicts higher mortgage rates to have a dampening effect on the market in 2015, "with expectations that the Bank of Canada will raise its overnight rate mid-year and longer-term rates will rise well before that.”

So, what can you do to insulate yourself from the looming threat of higher mortgage rates?

Simple, start planning for it – now. Stress-test your mortgage against a higher rate before you commit to your home purchase. Sure, you may be able to afford your dream home at today’s mortgage interest rate of 2.99 per cent, but in five years when it’s time to renew at 5.99 per cent (or whatever the number is at that time), will you still be able to make those payments?

Consult a financial advisor to help you determine what will work within your budget. With a clear view of the big picture, it’s easier to plan ahead, and purchase a property with confidence.

Buying a home is hugely rewarding, providing you’re prepared. Do your homework well in advance, and come mortgage renewal time and those Bank of Canada rate announcements, you won’t break a sweat.