On July 13, 2022, most in finance thought that the Bank of Canada would raise interest rates by .75%. That projected increase would already be considered jumbo-sized, but hardly anyone predicted a full 1% increase in the rate overnight.
I suspect that the Bank of Canada was looking at some last-minute inflation data within the United States, called an audible and added another .25% to the hike.
There are several questions that I am asking myself, and I am sure you may be wondering yourself.
The first thing you would need to do is see if you have a variable rate mortgage (VRM) or an adjustable-rate mortgage (ARM). The difference between the two is that a VRM payment will not change, but the amount of interest you pay per payment will adjust. If you have an ARM, the payment will adjust to any interest rate movement.
Mortgage payment increases or decreases will vary for each person based on what spread they had at the time their mortgage was funded. The spread would have been referred to as prime minus X% in your mortgage approval document.
If you have an adjustable mortgage, and If we use an average of a .5% discount/spread to bank prime (some spreads are more, some are less), mortgage payments will increase per $100,000 by about $98 per month for an original amortized mortgage of 25 years and $56 per month for a 30-year amortized mortgage.
2. What happens next? How many more rate increases?
If you are a client of mine, you most likely would have heard me state that if I knew 100% where rates were going, I would not be a mortgage broker but would be very rich sitting on some exotic beach. However, we can make some assumptions based on economic projections and historical data.
One question we must address is why rates are rising so rapidly. Well, the simple answer is Inflation which has, in my opinion, two different causes. The first is the supply chain disruption caused by the pandemic, and the second is the Russian invasion of Ukraine.
The pandemic created a situation where manufacturing on every scale was reduced or halted for a while. When the world started to reopen, there was a massive demand for goods that suppliers could not meet due to the supply chain issues caused by the shutdowns. The elementary rule is that when demand outstrips supply, prices increase, and we have an inflationary situation. Most were thinking and still think the supply chain would sort itself out, but there are continued setbacks centered on China’s Zero COVID policy. It also now seems that manufacturers are attempting to move some manufacturing away from China due to geopolitical issues.
As we started to see rates rise, I was advising my clients that this would continue for a while based on what I believed would be a reasonable timeline for the supply chain to stabilize but what none of us saw coming was an unprovoked invasion of Ukraine.
The invasion by Russia into Ukraine has caused a secondary bucket of Inflation, along with higher gas prices and food prices. The world is so intertwined that when a pebble is thrown into a pond, the ripple effects are felt everywhere.
The Bank of Canada has a delicate dance in raising rates to slow Inflation without creating a recession. It seems that most industrialized countries in the world will follow this methodology. Interestingly, forecasts are predicting a 50/50 chance of a recession occurring.
From what we know today, and this can change, the Bank of Canada may raise rates up to .50% at the next meeting, another .50% the following meeting, then .25% the next time.
Forecasts are a mixed message as GDP 2021 was 4.6%, 2022 is forecasted to drop to 3.5%, and 2023 is predicted to drop to .8%. However, the backdrop to these projections is that Inflation remains high, but the issue is that data is always lagging, a pebble in a pond, with the ripples appearing later. There are also signs that consumer sales are slowing at retailers such as Restoration Hardware, whose sales have already severely slumped.
A slowing of the economy will slow the pace of rate increases and will possibly result in rate decreases.
3. Will higher rates affect home prices and sales?
Any time you get any significant adjustment to borrowing costs, there will be some form of adjustment in a market. However, we must put this into perspective as I have seen more clients over the last 33 years make horrible decisions based on hyped-up media reports about prices going up or down.
My concern is that media reports will emphasize home sales and possibly some price reductions. The opportunity to purchase in a stalled market, or one that has slowed, can be a great opportunity.
What I think will happen is that there will be a period where prices pull back slightly, and listings will increase, creating a buyer’s market. However, based on future supply issues, once the Bank of Canada goes into a neutral stance or even has to reduce rates, the likelihood of another heated market becomes a tangible reality.
I would encourage you not to follow the crowd either up the curve of pricing or down the curve of pricing, but rather look at your needs on a long-term basis.
I am writing this blog from Vancouver, and even though the following may apply to other markets, it is mainly centered on Vancouver; however, other markets will have similarities.
Several factors affect a market, but my top five are:
a) Employment
b) Inventory Supply
c) Rental Inventory
d) Immigration & Migration
e) Mortgage Financing
a. Employment
B.C. has robust industries busting at the seams, such as the film & television industry, high tech, and construction, to name a few. The employment rate before the pandemic was 5.7%, and the jobless rate now stands at an all-time low of 4.9%. If a population is employed, they can pay their mortgage payments. If mortgage payments can be paid, the likelihood of stress selling will not occur.
b. Inventory Supply
Continuing issues in this market are: builders unable to secure permits promptly, labor shortages, and now costs outstripping profitability. Some builders are now delaying or canceling projects when the Vancouver market needs a substantial boost in housing starts.
Combined with the current shortage and an increasing shortage due to stalled construction, inventory will remain tight.
However, the caveat to this is that we will see a temporary lift in inventories that, in my opinion, will be short-lived
c. Rental Inventory
The Canadian government has mandated a target of over 425,000 immigrants annually. In the Vancouver market, our new Canadian immigrants have no option to purchase without incurring a hefty purchase tax. So most are opting to rent when landing in Canada.
The rental market has a similar issue to resale/presale homes as there has not been enough rental housing constructed. This, to me, seems to be some poor planning by the federal government in conjunction with provinces and municipalities.
If there is a shortage of purpose-built rental housing, new immigrants will gravitate to renting in real estate that is not designated for rental, putting further stress on the resale/presale markets.
d. Immigration & Migration
If you have only so much housing and a continuous stream of people into a geographic area, our rule of supply and demand comes into play.
As mentioned above, there are roughly 425,000 people immigrating to Canada each year, and I would guesstimate (I don’t have the stats handy) that about 15%-20% of the immigrants are coming to the Vancouver region.
Vancouver has also been a very desirable place to live, even with the high costs, so in addition to immigration, there is also migration from other provinces.
But the significant factor which seems to be ignored is that over the next 18 months, approximately 800,000 landed immigrants will be securing their permanent residency status. This will allow these permanent residents to purchase homes without the issue of an onerous sales tax.
Based on the year-end data, B.C.’s net migration reached 100,797 people in 2021, so let’s assume that 120,000 – 160,000 individuals will secure P.R. status in the region. How many will want to purchase? My experience is that a lot will.
e. Mortgage Financing
For the past five years, most buyers requiring mortgages have secured financing ranging from 1.5% to 3.50%. The current rate environment should not impact them, and one should note that if your mortgage was in the higher range around 3.5%, you could most likely renew into a variable currently in the range of 4.25%. The other factor is that most incomes over five years would have risen on average by 2% per year, offsetting any increase in payments. So mortgage renewals are unlikely to affect the market.
Buyers entering the market will experience elevated mortgage rates, but the access to mortgage capital is abundant, and lenders are ready and willing to lend to qualified buyers. As stated prior, the amount of qualification at the upper bandwidth will drop, but we usually don’t see the majority of our clients maxing out their mortgage beyond their means.
4. What to do at mortgage renewal?
Before writing this blog, I did some analysis. If one is coming up for renewal, the thought of current higher rates will be of concern. Based on the average rate in 2017 of 2.6%, the possibility of renewing around 5% as of July 17, 2022, your renewal payment to gross income (income adjusted to reflect a 2% average annual raise) is about a 3% hit your bottom line.
Not bad if you have been good with your finances for the past five years.
However, even though the math above would indicate that renewing should not be a concern at current higher rates, statistics tell us that Canadians have accumulated a lot of outside unsecured debt, which could be the real issue with higher mortgage payments.
If you are doing the math and have realized that the higher rates and other associated outside debt will cause you some cash flow issues, there are some solutions.
If you fall into the concerned category, I suggest you contact a qualified mortgage broker to review your options as soon as possible. Before reaching out to a mortgage broker, you should have the following information.
Once your mortgage broker has the above information, it may be possible to construct a plan that will adjust your overall payments to a much more reasonable level. It will also be vital for your mortgage broker to position your mortgage to give you some short-term rate security and the ability to take advantage when rates fall back in line with a 10-year average.
5. Will the higher rates affect my ability to qualify for a mortgage?
The amount you will be able to qualify for will get adjusted downward due to current rates and how the stress test is applied. The stress test was established to ensure that a mortgagor can withstand an increase in payments at renewal.
How much your approval will get adjusted will be based on the type of mortgage you take. Currently, a variable will get you a more considerable pre-approved amount as the stress test is lower than with a fixed mortgage rate.
But here is the reality: if prices move down slightly, the reduction in what you can qualify for will likely be offset by a slightly lower purchase price.
Most individuals applying for a mortgage do not apply for the maximum mortgage, so usually, there is room to qualify. I think the real question will be your comfort level with payments based on where rates are currently.
The most effective way to determine your payment comfort level is to work backward from your net income, subtract all your known financial commitments, and the balance potentially what you can commit to housing.
Provide this information to a qualified mortgage broker. They can very quickly calculate the maximum mortgage and put in place a mortgage plan to minimize any future rate increases or take advantage of further rate decreases.
Conclusion
The cause of current inflationary pressures is not what we experienced in the early 1980s & 1990s, which may be good news. Current interest rates are and have moved up due to inflationary pressures. The central banks are administrating a little pain now so that we can get back to a 2% target rate of inflation sooner than later.
I am not an economist, but from a ground-level layman’s perspective, I think the combination of higher rates for a while, supply chain issues easing, and the possibility of some form of resolution in Ukraine could see an easing of rates in 2023.
So, how does one take advantage of what now shortly seems to be a buyer’s market?
Finding the right home long-term is vital but constructing a mortgage that will give you some form of security and take advantage of rates falling in the future is essential.
There are several options for creating a diversified mortgage that will provide you with short-term security and the opportunity to take advantage of rates coming back down.
Having a long-term view with a balanced approach has worked well for many, and I hope it does for you also.
Michael Friedman
Michael has been an award-winning mortgage broker for the past 33 years. If you wish to discuss your mortgage needs with Michael, you can book a teleconference at https://calendly.com/canadamortgageprofessional/15-min
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