Time to start house-hunting?

Pros and cons of buying a home when rates are rising

Unless you’ve been away on a very long vacation for the past seven months, you know that inflation has been raging and interest rates have been steadily climbing. There have always been direct consequences of that – and always will be – for home buyers and for those shopping for mortgage financing.

As rates rise, there’s an immediate effect on consumer borrowing rates. Consumer loans, lines of credit, and rates for both fixed- and variable-rate mortgages rise. And that, in turn, has the effect of cooling of overheated housing markets. For both existing homeowners and new home buyers this can have both positive and negative effects.

Right away, the rise of interest rates is going to increase mortgage payments, especially if you are in a variable rate mortgage or if you are renewing your fixed-rate mortgage. The key is to understand the rate that will be paying and then get a focus on what your affordability is.

Basically it boils down to affordability. Can you withstand the increase in your mortgage rate as rates continue to rise? This means that Canadians are going to have to set aside more capital to be able to pay for increased rates, and that means re-visiting their spending and saving habits.

For residential real estate buyers, there are a couple of tips to keep in mind this early in the rate-hike cycle:

When to lock in variable rate. Those with variable rate mortgages should talk to their mortgage lender about locking in their low rate now. This is essential, especially if you’re right on the edge of your cash flow. Even a small hike in rates could boost your monthly payment past your affordibility threshold. Don’t take the chance on losing your home because you did not act when you were still able to.

When to consider variable rate. If you’re negotiating or re-negotiating a mortgage, and you need the lowest monthly payment possible, consider a variable-rate mortgage (yes, even though rates might rise again). The interest rate is lower, but the tradeoff is the risk that your payments increase if overall rates continue to climb. Keep in mind, too, that rates will not continue to rise forever. Central banks will ease up or stop rate increases when it looks like the economy is slowing down and inflation is dropping. In a couple of years, rates are likely to fall again. When that happens, holders of variable-rate mortgages will benefit as their interest costs fall. Your best bet here is to talk to your financial advisor who will crunch the numbers and show you different payment scenarios.

Shop, compare, negotiate. Shop around before you sign on the dotted line! Compare mortgage rates from different banks, credit unions, and mortgage lenders. Then get a quote from the lender to see what your “real” rate will be given your persoal financial situation (that is, down payment, home purchase price, location, mortgage stress test).

Should you extend amortization? Another way some borrowers try to reduce payments is to extend the amortization period for the mortgage. That’s lender talk for the time you are given in the mortgage contract to pay off the loan. The shorter the amortization, the higher the monthly payment. The longer the amortization, the lower the payment, but the more your total interest cost, usually many, many thousands of dollars more. Some lenders will allow up to a 30-year amortization. They don’t mind. They’re just getting all that much more lovely interest – out of your pocket! So use caution if you decide to play around with amortization.

Boost that down payment! The only really effective way to reduce monthly payments without putting yourself in hock to the bank for the rest of your life is to make the mortgage as small as possible by making as big a down payment as you can. And then making as many prepayments annually as are allowed in the terms of the mortgage contract.

First-time buyers: Buy now or hold off?

There is no crystal ball. It is impossible to tell you when you will hit the bottom of the real estate market. But what I can tell you is that housing affordability is now coming back in line for some Canadians where it was out of reach before. Prices of houses are falling while the interest rate is rising. So it’s going to create a pocket where people can get into the market where they couldn’t have gotten in before.

It is important to understand that real estate is one of the strongest places that Canadians build their wealth. Buying a home now with prices that are falling might be good (and they are going to continue to fall for another few months at least). But if you buy a house now, you have to be prepared for the value of that home potentially fall even further, at least temporarily, as real estate supply and demand work back to equilibirum.

For new home buyers, here are a few tips to help you navigate the market:.

Wait for the market to come to you. Those shopping for a home might consider delaying their purchase for a few months. As rates rise, overheated demand will cool off – and it does so very quickly. House prices are likely to start falling from their recent highs as the market readjusts, and you may well start seeing bargains appear – and have offers accepted below asking price, with no artificially low listing prices, engineered bidding wars, or other questionable sales tactics being used – something we haven’t seen for quite some time now.

Make a plan, Stan. When you do decide to go ahead, make a buying plan.

Save for the biggest down payment possible.
Check out registered savings programs and tax breaks like the First-Time Home Buyer Incentive, the Home Buyers’ Plan, and the Home Buyers’ tax credit
Calculate what you can afford to borrow. Brace yourself – this isn’t pretty. You have to look at your income, credit score, credit history, debt service ratios, loan-to-value ratio, and the mortgage stress test.
Work in closing costs, expenses not included in your debt service ratios, the cost of potential home repairs and improvements, and other expenses associated with buying that home.

Be prepared. Do this before going to see your friendly loans officer. That’s because what you think you can afford and what the bank will offer you are often two different things. You may have to adjust your expectations of the type of home, the location, or the price. So be prepared. Once you’ve jumped through all the hoops and you’re pre-approved for a mortgage, then it’s time to go house hunting.

Robyn Thompson, CFP, CIM, FCSI, is the founder of Castlemark Wealth Management, a boutique financial advisory firm specializing in wealth management for high net worth individuals and families. Contact her directly by phone at 416-828-7159, or by email at rthompson@castlemarkwealth.com for a confidential planning consultation.

Notes and Disclaimer

The foregoing is for general information purposes only and is the opinion of the writer. Securities mentioned are illustrative only and carry risk of loss. No guarantee of investment performance is made or implied. It is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice. Please contact the author to discuss your particular circumstances.