In one of my previous blogs, I wrote about the low interest rates we've been enjoying since the 2009 financial crisis and how there is strong evidence to suggest that interest rates will begin to increase over the next few months and years. Interest rates may not start increasing immediately, but in due time they will begin to do so gradually.
Have you ever considered the impact higher interest rates will have on your home buying choices? That nice house that you saw and qualify for today may be out of reach when -- not if, but when -- interest rates go up.
Consider this typical new home buyer scenario before the stress test introduced by the federal government last October. Suppose gross family income is $87,000, with household debt payments totaling $1,000 (credit cards, car payment etc.). If this person could put five per cent toward a down payment, the bank would qualify them for a $450,000 mortgage, which incidentally represents the average price of a single-family home in Calgary.
After October 17, 2016, when the new lending rules came into effect, and assuming there have been no other changes to this person's financial situation, the bank would only qualify them for a $360,000 mortgage. That represents a 20 per cent drop in their purchasing power.
You lose 11 per cent of your purchasing power for every one per cent of rate increase.
From one day to the next, this new home buyer went from being able to purchase a nice single family home with three bedrooms, two and a half baths, and a double garage, to only being able to purchase half of a duplex. In this type of situation it is better to be one hour early than five minutes late. Can you still find a single-family home in Calgary for $360,000? Maybe, if you look really hard, and if do you find one, it may not be in optimal living conditions or in a desirable neighbourhood. Believe me, higher interest rates will have a huge impact on the type of house you will be able to qualify for.
What happens when interest rates go up? The simple answer is that your purchasing power goes down. In fact, you lose 11 per cent of your purchasing power for every one per cent of rate increase. Which means that if interest rates increase to five per cent, which is where the federal government anticipates the interest rates will be five years from now, you will lose 27.5 per cent of your purchasing power.
That means that if we take the current average home price of $450,000, you will only be able to qualify for $326,250. Go to www.realtor.ca and do a search for a single-family home for under $325,000. You may be shocked to find out that there is nothing available in that price range.
Furthermore, don't think for a moment that the federal government is finished with the stress test. As interest rates go up, so will the stress test qualifying requirements. The stress test rate will move higher in tandem with the mortgage rates.
High interest rates did not keep people from buying then, and it will not keep people from buying now.
Many experts claim that the Bank of Canada will not increase interest rates anytime soon because it will kill the housing market recovery. In my opinion that argument does not hold water. If high interest rates keep people from buying, we would have had a market crash between 2005 and 2008 when the housing market in Calgary was super hot and interest rates were increasing every few months (until it topped off at around six per cent).
High interest rates did not keep people from buying then, and it will not keep people from buying now. In fact, quite the opposite, it encourages people to buy faster, before interest rates get even higher. Unfortunately, many first-time home buyers will find themselves out of the game and unable qualify for a mortgage, which the Bank of Canada will see as a positive thing because it will keep weaker applicants from getting into the market.
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