What really happens if mortgage rates increase?

Last week, we discussed the possibility of a small increase in mortgage interest rates. Bank of Montreal has just released a report stating that if interest rates rose by two per cent, it would strain affordability for a majority of home-buyers. BMO’s report predicts that 24 per cent of home-buyers would be stretched to afford a home in their current price range, but would not reduce their budget, while 30 per cent would be forced to reduce their price range and settle for a less expensive home. Another 13 per cent would be priced out of the market completely, predicts BMO.

Now, nobody has a crystal ball for predicting interest rates with 100 per cent accuracy, but if interest rates do increase, they will do gradually, likely not increasing by a significant amount in the near future.

Let’s take a look at some hypothetical numbers to see how a rate hike would impact affordability. This assumes a home-buyer needed to borrow $500,000 to purchase a home and planned to make monthly payments on a fixed interest rate during a 5-year term with a 25-year amortization schedule.

3 per cent* 4 per cent 5 per cent
Monthly payment $2,366.23 $2,630.10 $2,908.02
Interest cost for the 5-year term $69,339.80 $93,065.34 $117,004.47
Total interest cost at amortization $209,822.08 $288,953.11 $372,285.68

*Currently, some lenders offer interest rates below 3 per cent, but we’ll use 3 per cent as a nice round number.

The difference between a 3 and 5 per cent interest rate on $500,000 is a little under $600 per month. For home-buyers who aren’t shopping at the top of their price range and have some leeway in their monthly budget, this may not mean the difference between buying a new place or staying put. But for people (say first-time buyers in Vancouver who haven’t been able to take advantage of appreciation on a previous property) who are already stretching themselves on affordability, it could certainly hinder their ability to buy. It could get even tougher for a buyer who has a lot of other debt (say student loans, car loans or credit card debt) relative to their income, because mortgage lenders check borrowers’ credit and like to see a debt-to-income ratio under 35/42 (including the potential mortgage payment and other associated costs of homeownership).

If rates do increase, then the advice I’d give to home-buyers is the same I give today: work to pay down any debt and boost your credit score before shopping for a property that is realistically affordable to you, not one that is going to stretch you financially.

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About Atrina Kouroshnia

Atrina Kouroshnia is an independent, licensed, mortgage broker in the province of British Columbia. She has a degree in Human Relations & Commerce, and past work experiences in HR & Real Estate Development. She comes to the table with great customer service and problem-solving skills. Her approach to finding the best mortgage solution involves both short and long-term planning, making sure her clients are in a suitable mortgage that is flexible to their needs.