In one of the more hotly anticipated economic moves this past summer, the Bank of Canada raised interest rates for the first time in 7 years, lifting its benchmark interest rate to 0.75 per cent from 0.50 per cent
I talked in my summer forecast for Toronto real estate (click here and here to read Part One and Part Two) about how an increase in interest rates may be the missing piece in the affordability puzzle, by limiting the amount of money accessible to borrowers.
However, given the vast number of homeowners in Toronto that have become heavily indebted as a result of furious pace of the market over the last couple of years, this hike is not something to take lightly. For example, at the last rate increase seven years ago, the average home price was just over $427,000. Now it’s just shy of $800,000. As prices have gone up, so has mortgage and consumer debt.
This current rate increase is modest and while it will cause most homeowners slight tremors as opposed to financial earthquakes, homeowners that have been focused on taking out as much mortgage as they can just to buy in this hot market, may want to take this rate hike as an opportunity to get their financial houses in order.
So what should homeowners do? Take a moment to consider how an interest rate hike impacts their personal finances and develop a plan to reduce vulnerability. That means paying down debt strategically before rates increase more, as well as anticipating extra costs in your household budget as a result of this and future rate hikes.
The Psychological Factor
Don’t underestimate the psychology of a rate increase, especially when you consider the role that emotions and psychology have played in shaping the real estate market (i.e. the Fear of Missing Out, heated bidding wars, etc.). It’s been seven years since the last rate increase. That’s a long time. What’s more is that rates have held at historic lows for much of that period. That’s enough to construct a false sense of reality in terms of a borrowing environment. Many homebuyers – particularly first time Buyers – have vague if any memory at all of having to pay higher interest rates.
In addition to impacting your finances, a hike in rates is going to impact your perception of your finances. You will now be able to borrow less money, which on the surface may seem like it erodes your purchasing power. While this is in fact true, it is also limiting your ability to take on more debt, which is crucial not only to making Toronto more affordable again, but also is crucial in reducing overall debt-which is one of the great dangers that exist as a by-product of a frothy housing market.
That said, you need to adapt your mindset to reflect a new reality. This is the first rate hike in ages. There will be more, but the climb will be gradual, which means that implementing some changes now, both mentally and tactically can help you absorb extra costs.
House Hunters Act Now
If you are looking for a home, make sure that you get your rate locked in with your lender. Most lenders will honour a 90 to 120 day rate guarantee. This item on your house hunting list just moved to the top position. As you probably already know, housing searches can be lengthy, so you want to do what you can to proactively protect yourself against rate increases. The Bank of Canada just hiked the interest rate for the first time in seven years by 0.25 per cent, from 0.5 per cent to 0.75 per cent, and the next rate announcement will be on September 6th, 2017. But lenders could certainly raise rates on their own between now and then, based on the key lending rate.
Rob Carrick of the Globe and Mail offers a game plan for aspiring house hunters, and asserts it’s important to understand that “rising mortgage rates are as much your enemy as your friend”.
When Does Your Mortgage Renew?
Depending on when your mortgage is up for renewal, you might consider locking in early. If rates continue to climb, it might make more financial sense to lock in now. At the very least, spend some time now anticipating what a hike in interest rates might do to your mortgage payment. You can adapt your budget accordingly over time.
If you have some cash on hand, consider making a lump sum payment before your mortgage renews, which will reduce the amount that you’ll be financing at a higher rate.
Don’t Forget Your Other Credit Products
It’s not just your mortgage payment that will be impacted by a rise in interest rates, but any credit product that you’ve got that is linked into the overnight lending rate. This is likely many of your credit cards, or more significantly your homeowner line of credit (as you tend to have a higher balance, which will translate into a higher payment).
Have an auto loan? Most car loans are fixed payment, but some lenders offer variable rates with their loans. It’s worth checking the fine print, because if your payment is based on a variable rate, it’s going up too.
Pay Down What You Can Now
In the buying frenzy that has characterized the Toronto market up until a few months ago, the emphasis has been on taking out as much debt as is necessary just to land a property. With that debt getting more expensive, the emphasis needs to be shifted towards trying to pay some of that debt. The higher rates go, the less “mileage” you get with your debt repayment.
For your line of credit and credit cards, pick the balances that earn the highest interest rate, and put down what you can additionally on those. You are better served to focus as much as you can on a single debt, than “spreading it around”.
Variable Mortgage Holders
If you’ve got a variable mortgage rate, and have been taking advantage of the low interest rate environment, it may be time to consider locking into a fixed rate. It really comes down to your risk tolerance. Given the likelihood that rates will be heading upwards now instead, it comes down to whether or not you can balance out the risk of having to deal with higher rates.
Is This A Good Time To Renovate?
If you’re like me and about to embark on a significant renovation (here’s my journey chronicling my transformation of a 1960s purpose built Riverdale duplex in The Tales From Tennis Crescent), you might want to revisit whether now is the time to proceed (I gotta admit, I’m hesitating). With rates going up, you may want to reconsider the timeline and/or the scope of your renovation project until you’ve got more cash amassed. While home renovations fall under the “good debt” category because they ultimately help you to improve the asset value of your home, any debt is going to cost you more as rates rise. And with it, be cognizant of how an increase in interest rates might impact your income. If you’re self-employed like me – and in an occupation that’s vulnerable to people’s spending patterns – you might want to prepare yourself for a potential shift in the economy as a whole. I could very well see my income drop as higher rates = fewer property transactions.
Want to learn more about how interest rate increases could impact your finances? Check out these stories: “Will The Bank Of Canada’s Interest Rate Hike Affect Lines Of Credit? Yes, And Here’s How To Manage It”, “Mortgages Won’t Be The Only Problem For Many Canadians As Rates Rise”, “What Rising Interest Rates Could Mean For Your Mortgage” ,“How Borrowers, Savers And Investors Can Prepare For Higher Interest Rates” and “Interest Rates Likely To Increase Today: How That Could Affect Your Loans”.
Real estate is a dynamic entity and you need a strategy that moves with the market!
Have questions? Please know my team and I are to help!
~ Steven and the Urbaneer Team
Steven Fudge, Sales Representative
& The Innovative Urbaneer Team
Bosley Real Estate Ltd., Brokerage – (416) 322-8000
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