Putting rising interest rates into perspective

After a few years of historically low mortgage interest rates, Canadian homebuyers are now dealing with the results of recent Bank of Canada rate hikes, which are necessary to help fight inflation.

Although these increases affect your homebuying power, it may not be as much as you think. For example, according to statistics from the Government of Canada, if you take out a mortgage of $400,000 with a 25-year amortization, at four per cent interest rate, your monthly payment amount would be approximately $2,104; at five per cent, about $2,326. That’s about $222 more, or a minimal amount of discretionary income for many Canadians. Unless you make yourself what we refer to as “house poor,” this should be manageable.

Several parameters

Keep in mind that your lender uses several parameters to determine your mortgage rate, such as their current prime and posted interest rate, amortization and length of the term you choose, the kind of interest you select (fixed or variable), your credit history and current debt situation, employment status and whether you qualify for a discounted rate, among others. When you do your research to determine what you can afford, planning on interest rate rises in the future should be a consideration. Our conservative Canadian banking practices help to protect people from becoming overextended and creating the kind of scenario we saw in the U.S. a few years ago.

Putting things into perspective, about five years ago, five-year fixed-rate mortgages were on average 4.64 per cent. In fact, over the last 25 years, the average for that type of mortgage is 5.65 per cent. On June 1, the Bank of Canada raised its overnight target to 1.5 per cent, and before the pandemic, it was 1.75 per cent.

Looking worldwide, Trading Economics (tradingeconomics.com), which gathers information on 196 countries through official sources, reported on June 17 that the mortgage rate in Australia was 4.72 per cent; in the UK, 4.25; and in the U.S. 5.65.

Avoid overextending

Another way of looking at things is to consider those who purchased during the lockdown because of COVID, when their rate was likely below 2.5 per cent. Yes, when they go to renew after five years, their rate will be higher, but so will their property value. In addition, they will have been paying on their mortgage for years. Remember that for pre-construction homes and condos, owners often earn equity before they even take possession.

Not to sound like the parents who walked five miles uphill in snow to get to school as kids, but ask them about the 1980s and 1990s in Canada, when mortgage rates skyrocketed into the double digits. They did what they had to do to cope, including giving up unnecessary luxuries.

The moral of the story is to avoid overextending your financial reach when purchasing a home. Your financial advisor should help you determine what you can comfortably afford, allowing for the unexpected, such as interest rate rises.