Warren Buffett said Monday the U.S. economy had “fallen off a cliff” but would eventually recover, although a rebound could kindle inflation worse than that experienced in the late 1970s.
Although Warren is speaking about the U.S. economy, Canada has mirrored its big brother in almost all respects during this global recession. Unemployment rates have risen as job losses mount. Both governments have bailed out and propped up industries, and cut interest rates to historical lows.
Last week, the central bank lowered its key overnight rate Tuesday to 0.5% — a record low. Many observers say the bank could even take the rate as low as it could go – 0%, in an effort to spur economic growth.
Because of the falling rate of inflation, the BoC was comfortable with lowering the interest rate. Eventually, the economy will rebound and with interest rates almost as low as they can go, you can be assured that as soon as inflation begins to manifest itself (it’s inevitable with the “quantitative easing”, central banks printing money to inject into the system) interest rates will rise in order to rein in core inflation within acceptable limits.
Over the past 40 years, Canada’s average annual inflation rate has varied. It reached a high of 12.4% in 1981 and has averaged 1.6% between 1992-2000. The current target range the BoC shoots for is between 1%-3%, within which the Bank aims at the 2% target midpoint.
Fluctuating inflation rates (and by extension, interest rates) is where you should be careful when budgeting for a home. Unlike the U.S., your mortgage interest rate is not fixed for the entire period. With a common term being 5 years, you’ll need to budget ahead for possible scenarios, and purchase a home within your budget now – and the future.
I’ll use a $400,000 home as an example, and for simplicity’s sake, we’ll assume that’s the cost after your minimum 5% down and CMHC fees.
$400,000 Mortgage
4.5% interest rate
5 year term
25 amortization
Your P.I. would be $2,213.89
After 5 years, your remaining balance would be $351,185.55. However, this is where you’ll need to renegotiate for a new interest rate.
At 5.5% your monthly payment would then be $2143.61.
- 6.5% = $2352.32
- 7.5% = $2569.12
Of course, no one really knows exactly where interest rates will be 5 years from now… but if the BoC drops their rate even further from 0.5% to 0% – after that, they can only go up.
Plan head, and don’t buy the maximum home you can afford at today’s interest rate — leave yourself a little cushion so you can breathe easier and enjoy your new home down the road.
Another option is to lock in for a longer length of time at a good rate. I just saw 10-year fixed rates for 5.25% advertised by Scotiabank and Centum. Definitely worth looking at those longer terms now.
Disclaimer: I’m not an economist, financial advisor, or mortgage specialist. Please speak to one of them for expert advise regarding interest rates and your mortgage.
13 responses so far ↓
cj // March 9, 2009 at 1:59 pm
Great comment Mike. My rule of thumb has always been, buy when interest rates are high because prices are usually low and rates only have one way to go. Its highly unusual that home prices are decreasing with interest rates so low. We live in strange times indeed. My personal guess is that we are at least a few years away from raising interest rates…deflation will be here for a while. Therefore anyone buying today should buy on a variable and watch for any sign of inflation. I think rates will go lower and stay low for a while. Even when inflation hits govt could well try and shield homebuyers…they certainly wouldnt want to plunge us back into another recession!!
Mike Fotiou says: I agree, I don’t think we’ll be seeing interest rates rise for a while.
Talking // March 9, 2009 at 10:35 pm
Interesting subject indeed. To claim increased afordability, based on temporary record low interest rates is a silly statement, I expect better than that from business “analysts”.
Subprime was not a problem in the States until it turned into Overprime (a lot over), that was the turning point when the subprimers could not afford to pay their mortgages anymore. Same thing could happen here, whatever appears afordable today, could very well turn into impossible to pay, 5 years down the road.
Banks, lenders and real estate business should post big signs everywhere, to read “BORROW/BUY AT YOUR OWN RISK” instead of “best time to buy” ones.
Mike (authentic) // March 10, 2009 at 3:19 am
I’m glad you are bringing this up Mike, and really it’s great prudence on your part to do so and educate your clients on this matter.
I’ve noticed on CNBC they are taking more and more about mortgage rates going up and already the LIBOR rate (interbank lending rate) stopped it’s decent a few weeks ago is now slowing going up.
Thus, I expect pressure on rates to start heading up sooner than 2 years if pressure continues and LIBOR keeps increasing, Canada keeps printing money OR, if the US starts having issues raising funds (treasury).
Anyone buying today might as well sign up for a 10 year fixed at 5.25% (CIBC). It’s as good as it’s going to get and I’ll put money on in 5 years time you can’t get a 5 year for 5.25%.
Histoically, prices/rates go up faster than they come down (gas prices anyone?). Mortgage rates are no different. I don’t have a chart going back to 1980 (anyone?) but in Jan 94 rates were 7.5% (5yr fixed) and 6 months later were 10.75%!
Talking made a good point about OVERprime rates. Buyers really need to think can they afford that home when rates go up again by 2%, 5%? And think about the RIFI mortgages when houses are underwater already. The longer the housing market keeps going down, the more trouble people will have RENEWING their mortgage. In your example Mike, $351,185.55 is what the loan on the house is at, but what happens if the house is only worth $320k or $300k? The bank has the right to say NO. That is what is occuring in the USA right now. Why 1 in 5 homes are foreclosed on, why 8.3 million homes are worth less than their mortgages right now. Scary stuff.
Even with the taxpayers money don’t expect the banks to give the taxpayer a break. Banks are there to make money and will only loan out if they make money on it.
A good post as well today:
http://www.canadianmortgagetrends.com/canadian_mortgage_trends/
Mike
Mike Fotiou // March 11, 2009 at 8:33 am
Thanks for your thoughts, Mike & Talking.
New home prices continued to decline in Alberta – Calgary 6.5% year-over-year (Edmonton at 10.4%)
As well, CREB now has a Cumulative Days on Market Stat. This is a combined total of the Active Days on Market, and the Days on Market of a listing of the same property that was on the market within 30 days of the most recent listing. In order for the CDOM to reset to zero now, a property must be off the market for at least 31 days.
I’ll write up a post and compare the DOM stat to the more accurate CDOM stat. I think this is a great update to better reflect how long homes are staying on the market.
cj // March 11, 2009 at 8:35 am
hi mike, i have a question…I was speaking to a realtor yesterday who said that people are not buying new homes but are instead opting for existing. As a result builders are dropping prices for new construction (around $125/sq ft). Are people not buying because they are worried about locking in a price and when the house is finally built and they try and get financing the value has dropped and can’t get a mortgage? Are you seeing or hearing this to be true?
thanks
CJ
Mike Fotiou says: Hello CJ, good timing, I just posted a link to an article above regarding new home prices. I’m not sure what the price drop per square footage is industrywide, but this was a quote from one builder last month: Allan Klassen, president and managing partner of Albi Homes “I can confirm that to buy a 2,500-square-foot two-storey Albi home today versus one year ago our prices have come down by over $100,000.” (source) So, it’s down at least $40/sq ft. for them (or at least for that model)
Mike (authentic) // March 11, 2009 at 2:16 pm
“As well, CREB now has a Cumulative Days on Market Stat. This is a combined total of the Active Days on Market, and the Days on Market of a listing of the same property that was on the market within 30 days of the most recent listing. In order for the CDOM to reset to zero now, a property must be off the market for at least 31 days. ”
Finally, a useful DOM stat!
But why would CREB do it now when they know DOM is up and it could hurt them? I don’t see a “positive spin” for them in doing this…Won’t it will remove the “magic bullet” for many a realtor out there as well…?
For the consumer, it’s great news I believe.
Mike
Mike Fotiou // March 13, 2009 at 9:35 am
Alberta launched new building and fire codes that builders have to adhere by before May 3rd. Although this is commendable, it’s a shame it wasn’t implemented a year or two earlier when thousands upon thousands of homes were being built.
Will new home builders absorb the approx. $10k hit, or pass it on?
Calgary home builders feel burned by new Alberta fire safety rules
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REMAX released their First Time Buyer’s Report this week. I’m a little surprised to see that they consider up to $400k as an entry level price point for a first time buyer. With average prices hovering just above that, I bet they consider prices to be in line with what Calgarians on average incomes can afford…
Cory // March 15, 2009 at 8:36 pm
Good points Mike. Unfortunately, people only see today/short term and I expect a big bloodbath when people go to renew their mortgage and people find they cannot afford even a .5% rate increase if they maxed out to begin with, which alot do.
House and condo prices have a long ways to go yet before they really become affordable and match the median income levels. The numbers still do not balance and when interest rates inevitably climb real estate prices will have to drop.
The best thing to do is sit in cash and wait for inflation to come roaring in an simply lock in your cash for a double digit interest rate paid to you rather than paying it to the banks via a mortgage.
The problem with my proposal is people simply do not want to wait and will buy an oversized house/storage shed they cannot afford anyway. And two, generations have been brainwashed that real estate is the only and best way to financial freedom, which is simply not true. I have always sat and waited for things to come to me even if I have to wait a few years for it to happen and we now sit in a great cash position with no debt today because of it. We also lived for “free” for over 14 years because of our real estate moves at the right times. So it can be done. Now we are sitting and waiting (again) for the market to continue to correct, and it will continue to do so, until we buy again, or not.
Mike (authentic) // March 16, 2009 at 1:47 am
“REMAX released their First Time Buyer’s Report this week. I’m a little surprised to see that they consider up to $400k as an entry level price point for a first time buyer. With average prices hovering just above that, I bet they consider prices to be in line with what Calgarians on average incomes can afford…”
I would myself consider a entry level price point to be $230-270k. Our first starter home in 2004 was $178k in Millrise and we did ok with the mortgage at 4.65% 5 yr with 10% down with Calgary average incomes. We stayed away from looking anything over 210k though.
I can’t see incomes changing by 100% in 5 years.
Mike
Anon // March 16, 2009 at 9:29 am
I agree with you. We are looking at under 300k as our limit, and we both work with reasonable income. There is no way we could afford 400k house – though the mortgage brokers keep insisting we can, and have pre-approved us for that amount.
Cory // March 17, 2009 at 5:37 pm
The other problem is people only look at mortgage payments, not carrying costs which are quite high now too. Then the failure to factor in a possible illness o rhealth issue and it all falls apart very quickly.
Add parking fees at the park and ride and there is no room for error!!
Jones // March 27, 2009 at 8:20 am
We’re waiting for the market to settle down but it seems to be slow to correct. The number of layoffs, increased foreclosures and the large increase of bankruptcy claims are, in my opinion, leading indicators of markets to come. If interest rates increase even 1% with depressed market prices you may see a huge increase in foreclosures and a rapid decline in housing prices.
But that’s just my opinion.
Bottomed Out? « // June 24, 2009 at 10:57 pm
[...] Even with interest rates so low, I encourage those buying to budget enough for increased interest rates for when your 1-5 year term is up and you have to renew. You can read my blog post: Budget & Plan Ahead for Higher Interest Rates. [...]