Canadians have been enjoying outrageously low interest rates for years; in fact, the Bank of Canada’s benchmark rate remained unchanged at 0.5% for 7 years, until it was raised to 0.75% in July 2017. Many economists believe this recent interest rate hike will be the first of a few hikes that will see the prime rate rise to 1.5% next year….still incredibly low by historical standards, but a significant change nonetheless.
Low interest rates have fueled Toronto’s real estate market for years. So what does this mean for prospective Buyers, Sellers and Homeowners?
First, let’s put interest rate hikes in perspective, in real dollars. Example: You purchase a $625,000 home with a 20% downpayment, leaving a $500,000 mortgage balance. Amortized over 25 years, your fixed rate payments would be:
- At 2.50% – $2,240 per month
- At 2.75% – $2,303 per month
- At 3.50% – $2,600 per month
We can probably all absorb an extra $60 payment a month. But $300? That’s not pocket money for most of us.
How Do Rising Interest Rates Affect New Buyers?
If you’re thinking of buying in the next 12 months, recognize that:
- Interest rate hikes make buying a house more expensive. The 0.25% interest rate hike translates to an extra $13 per month for every $100,000 of mortgage;
- The interest rate affects how much money you can borrow. Lenders have very strict rules about how much money they will lend and interest rates impact that. For example: A family earning $150,000 per year with a $50,000 downpayment can afford a house at $677,297 when interest rates are at 2.67%.
- At 3%? That number drops to $659,539.
- At 4%? $609,901.
- At 5%? $565,483.
- Toronto prices have declined in the last few months, though are still up in the past year. It’s possible that prices will fall further before they bounce back up…but will they fall enough to counter an interest rate hike?
Pro Tip: If you’re thinking of buying in the next 12 months, get pre-approved and locked into a mortgage rate now. If rates go down, you’ll still get the lower rate – but if they increase again? You’ll be locked in. Most mortgage pre-approvals are valid for 90 days, so you’ll probably need to repeat this exercise every 90 days until you buy.
How Will Interest Rate Hikes Affect Sellers?
If only I had a crystal ball.
Past interest rate hikes in Toronto have resulted in increased short-term buying activity (usually for a month or two), as Buyers with locked-in rates from before the hike hasten their purchasing.
BUT….the biggest factor at play in Toronto’s real estate market right now is Buyer psychology, and that’s almost impossible to predict. If Buyers think rates will continue to increase, they may buy sooner rather than later to take advantage of today’s lower rates; but they might also see an interest rate hike as one more reason to be nervous and wait for prices to come down.
Current Sellers take note: combined with the effects of the Ontario Fair Housing Plan, an interest rate hike might further slow down the market.
How Does It Affect Home Owners?
If you’ve already got a mortgage, you might think interest rate hikes don’t affect you. Wrong! When you first got your mortgage, you made a few important decisions:
- Amortization Period (usually 25 or 30 years)
- Mortgage Term (usually between 1 and 5 years).
- Type of mortgage: Fixed or Variable
- Interest rate
At the end of your term, your mortgage will come up for renewal – meaning that you’ll be subject to the prevailing interest rates. If current interest rates are higher than your old rate, your monthly carrying costs are going to go up. I highly doubt interest rates will go up so high and so fast that masses of people won’t be able to afford their houses anymore and be forced to sell, but owning a home will certainly be more expensive.
Variable Rate Mortgages
If you have a variable rate mortgage, the amount of your payment floats with the bank’s prime interest rate, so your interest payment will go up. If you’re carrying a $500,000 mortgage, expect to pay an extra $63 per month after the recent hike.
Most variable rate mortgages have the option of converting to a fixed-rate (meaning your payment won’t vary with the interest rate). Historically, variable rate mortgages have been cheaper, but if you think interest rates are going to continue to increase at a fast pace, you may want to consider converting to a fixed-rate mortgage.
Pro Tip: Stop trying to time the market. I don’t have a crystal ball and neither do you. Do the right thing for you, whether that’s deciding to buy now, buy later or deciding to sell.