Rising mortgage rates impact housing affordability Rising interest rates, large mortgages and high consumer debt – combined with an uncertain economy – are setting the stage for dangerous times for Canadians. Although housing prices have dropped in some areas, the cost to own a home is still high compared to average income, and many prospective homebuyers will not pass the new mortgage stress test. This is forcing some people to consider less expensive options, such as condos and townhomes, which is driving up the cost of these properties. Canadians are worried A December 2017 Ipsos survey revealed some staggering findings: more than 40 per cent of Canadians believe that, if interest rates keep going up, they will be in financial trouble – and about one third of respondents fear that they will have to declare bankruptcy. Interest rates have already gone up once this year, and more increases are expected within months. The survey also found that one third of Canadians cannot cover their monthly bills and keep up with debt repayment, and almost half are within $200 of not being able to meet their financial obligations. Even with these fears, Canadians are continuing to take on more debt. About half of the people who responded to the poll said that they will go deeper into debt to cover their expenses. Younger Canadians are at particular risk, as they have lived with very low interest rates and have developed the habit of financing many purchases. According to a Leger poll conducted at the beginning of 2018, young Canadian households (who often look to rentals for their first place of residence) are feeling the financial stress even more than their older counterparts. The survey showed that 20 per cent have credit card balances larger than their savings account, 21 per cent overspent during the holidays and six per cent are receiving calls from bill collectors.
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Interest rates and borrowing power There is not always a direct correlation between an increase in general interest rates and mortgage rates. Usually, as interest rates rise, the chartered banks raise their posted mortgage rate – but a rate increase does not always mean a matching mortgage rate increase. For example, in January, the overnight interest rate went up by 0.25 per cent, but the fiveyear conventional mortgage rate increased by 0.15 per cent. This raised the five-year mortgage rate reported by the Bank of Canada to 5.14 per cent. When the mortgage rate does increase, it also reduces borrowing power (or affordability). Increasing the interest rate from 4.99 per cent to 5.14 per cent reduced borrowing power by about 1.68 per cent. This means that, if a household was earning $100,000 per year, then the amount that they would be allowed to borrow toward a mortgage dropped from $534,594 to $525,577 – a decrease of $9,017. That difference in borrowing power means that the household must raise more funds to get the house they want… or find a less expensive place to buy. With the increased interest rate comes more interest paid on a long-term mortgage. According to the Canadian Real Estate Association (CREA), the composite aggregate benchmark price (i.e., the price of a typical home in Canada) was $600,300 in December. Buying with a down payment of 20 per cent would mean a mortgage of $480,240. Getting a mortgage at a fixed rate of 4.99 per cent would result in $446,795 in interest over 30 years. If you waited until the fixed rate was 5.15 per cent, the interest costs would be $462,700 – or an additional $15,905 over 30 years. Mortgage stress test Stricter mortgage rules will prevent some potential homebuyers from purchasing a new home, and might make it difficult for current homeowners to renew their existing mortgages. Under the new mortgage stress test, buyers will have to show
that they can keep up with payments if the mortgage rate increased by two percentage points. Assuming a down payment of 20 per cent and a 2.99 per cent five-year fixed mortgage rate (with 25-year amortization), potential homebuyers of the average single-family home in various cities will need the following down payment and annual income:
homeowners were spending at least 30 per cent of their income on paying their shelter costs. At the same time, there were 4,452,875 renters (both subsidized and not) in Canada. Of those, 795,935 renters (or nearly 18 per cent) had a shelter-to-income ratio of 50 per cent or more. Another 979,635 renters (or 22 per cent) had a shelter-to-income ratio of 30 to 50 per cent. So, about 40 per cent of renters were spending at least 30 per cent of their income on paying their shelter costs.
Down payment Annual Income
The changes in the mortgage stress test are already keeping prospective homebuyers out of the home ownership market. In turn, that will increase the demand for rental units from what we have seen in recent years. Rents are already rising sharply in Toronto and Vancouver because of the various effects of sharply rising home prices. When they come, increases in mortgage interest rates will impact the rental market, as well as the market for home ownership.
Income is not the only factor that will affect the mortgage stress test. Non-mortgage debt, such as credit card payments and car loans, is also part of the equation. Lenders want to ensure that total debt takes up no more than 42 per cent of annual pre-tax income. Every $450 in monthly debt obligations will reduce the amount of mortgage a person qualifies for by about $100,000.
By David Gargaro
Shelter-cost-to-income ratio The most recent Statistics Canada data (2016 Census) paints an interesting picture of how much Canadians are spending to live in their homes. The shelter-costto-income ratio is the proportion of the average total household income that is spent on shelter costs. Shelter cost is defined as â€œthe average monthly total of all shelter expenses paid by households that own or rent their dwelling.â€? For homeowners, shelter costs include (where applicable) mortgage payments, property taxes and condominium fees, as well as the costs of electricity, heat, water and other municipal services. For renters, shelter costs include (where applicable) rent and the costs of electricity, heat, water and municipal services. According to Statistics Canada, in 2016, there were 5,687,455 homeowners with a mortgage. Of this total, 497,310 (or 8.7 per cent) had a shelter-to-income ratio of 50 per cent or more. This means that they were spending at least half their income on paying their shelter costs. Another 811,465 households (or 14.3 per cent) had a shelter-to-income ratio of 30 to 50 per cent. This means that 23 per cent of
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