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|
|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.