Gord Honor – Broker at Berkshire Hathaway HomeServices
Housing sales volume may be decelerating, making buying a home easier, but not necessarily less expensive. At the fastest rate in 40 years, hyperinflation is making all goods and services more expensive globally., including mortgage interest rates. Should you still buy a home with interest rates climbing upward? Here’s the long answer.
Hyperinflation is a situation where goods and services rise rapidly over a defined period. Decreasing the money supply by making it more expensive to borrow reduces consumer spending and slows down the economy. This action decreases the pace of inflation, which is why the Bank of Canada has raised overnight borrowing rates to banks no less than four times in 2022 so far. The last rate increase in July 2022 was .100 basis points – the largest increase since 1994.
Mortgage interest rates are calculated in basis points. A basis point is one-hundredth of a percentage point. Using basis points adds clarity to understanding mortgage interest rates and the impact on borrowers’ monthly payments when basis points increase or decrease.
Banks pass along the cost of borrowing from the Bank of Canada to consumers which is why mortgage interest rates have risen so quickly this year. Banks calculate risk in a number of ways, such as world news, inflation, employment, and underwriting guidelines. Based on these factors, the job of underwriters is to determine a borrower’s ability to repay the loan. They look at employment records, income, debts, and financial assets. They review tax returns and your debt-to-income ratio. What they’re looking to assess are the three C’s: your credit, capacity to repay, and the collateral you own as well as the home you’re buying. They want to know how quickly you repay other loans and lines of credit, whether you have the income and control of your debts to allow you to repay your loan, and whether the home you’re buying will meet a bank appraiser’s value. With your home as collateral, the bank theoretically won’t lose money in case you default.
Documentation takes time to review, so what banks typically do is pull your credit report first so they can get your credit scores. Credit scores are supplied by credit reporting agencies to provide a kind of shorthand to lenders that they can use to approve or deny loans, but credit scores are also used to help determine the interest rate that the bank charges a particular borrower.
As a borrower, you may wonder why the interest rate you’re quoted may be higher than what you see advertised on the Internet. Advertised rates typically reflect best-case scenarios based on insured mortgages or for the most financially qualified borrowers, a caveat that’s posted somewhere in the fine print. Some common parameters for getting the best mortgage interest rate may include a minimum credit score of 740 and a maximum loan-to-value of 60 percent or 80 percent or receiving an insured mortgages.
So, if a mortgage interest rate is advertised at 4.25%, your rate may be higher because of less than perfect credit. Rising mortgage interest rates are tough on borrowers because every increase in basis points translates to a higher monthly payment and as much as thousands of dollars over the life of the loan.
Let’s say you’re looking at buying a $800,000 home with a 30-year amortization period. Using a mortgage calculator, you input $160,000 as a down payment and a projected mortgage interest rate of 4.25%. Your mortgage payment would be $3,135. If the same loan were 5%, only 75 basis points higher, your monthly payment would jump to $3415, or about $280 more per month.
So what does all this mean for you, the homebuyer? It’s a matter of perspective. Since 1971 the highest mortgage interest rate ever recorded was 19.25% in 1982. The average house cost $95,496 in 1982, with a monthly payment of $1,184. At the average home price for 2021 of $1,095,339 after putting 20% down, if interest rates were the same, your monthly payments would be about $11,033.
What drove interest rates so high in 1982? The same conditions as we’re experiencing today – runaway inflation, high oil prices, and rising wages caused the Bank of Canada to raise overnight borrowing rates 20 basis points that year. In 2022 so far, the Bank of Canada has raised rates only 2.5 basis points. Considering that the all-time lowest 5 year fixed rate mortgage was around 1,9% in 2016, four or five percent interest isn’t that high in the grand scheme of things.
There is one notable difference. There wasn’t a housing shortage in 1981, but we have one now. In 2021, research showed that the the Canada would be short 3.5 million homes by 2030 and by 1.85 million in Ontario alone.
Will home prices come down? As long as there’s demand, prices may level off but it’s unlikely that they’ll fall, as they’re making up for years of tepid demand, a jobless recovery, and stubborn wage growth. But that could change. In June, 2022, mortgage demand was down to the lowest level in 22 years. Housing sales volume for the Toronto Real Estate Board was down 34.2% from August 2021 while average prices were still up year over year.
These changes show that demand is being impacted by raising mortgage rates and other factors, but that sellers remain patient for the right buyer. At the same time, the shift in demand from buying to renting has put massive upward pressure on rental rates. The average price for a 1 bedroom in Condo now sits at $2100 and increase of $300 or 15% from August 2021. For 1 bedroom condos the pricing has increased from $2250 to $2700 over the same period.
So should you look to buy in the current higher interest rate environment? The reality is that we are still in a historically low rate environment, and waiting for lower rates might not be the best path forward. While prices may continue to see downward pressure in the coming months, the demand for housing will remain incredibly high for years to come, thus placing long term pressure on upward pricing. Our advice is simple, if you are thinking of buying, get yourself approved for a mortgage so that you can be ready when you feel like the time is right or you find the perfect property for you.