Whether you own a house or are looking to buy, rising mortgage rates are your enemy.
You think you know that, right? With Monday's announcements that Toronto-Dominion Bank and CIBC are raising some of their fixed-term mortgage rates by as much as one-quarter of a percentage point, let's see if you do.
Rising rates will make affording a first home much harder - so much so that you'll pay more even if housing prices decline. Higher mortgage costs will also shrink the cash flow of families that stretched to buy a home but were getting by in a low-rate world - potentially by thousands of dollars a year.
People looking for a home face astronomically high prices in some cities, but they benefit hugely from very low mortgage rates. What a dilemma these people face - buy now to lock in manageable borrowing costs for a while, or risk higher mortgage rates while hoping for housing prices to fall.
That could happen. A firm called Capital Economics has raised the possibility of housing prices falling 25 per cent in the next few years, in large part because of rising interest rates. Even the Canadian Real Estate Association has projected a price drop of 1.3 per cent this year.
Let's say prices fall 5 per cent over the next 12 months, enough to take the national average house price in December to $327,322 from $344,550. How would this play out from the borrower's point of view?
With a five-year fixed-rate mortgage at 3.9 per cent and a 10-per-cent down payment, you'd be looking at payments every two weeks of $823 (includes mortgage insurance and a 25-year amortization) if you bought now.
Now, we flash ahead a year to find that mortgage rates have climbed a full percentage point. You're now buying a $327,322 house and taking a five-year mortgage at 4.9 per cent. The new biweekly payment: $865, which plays out to an extra cost of $5,460 or so over the five-year mortgage term.
Imagine you use your year on the housing market sidelines to build up your down payment by, say, $5,000. This lowers your biweekly payment only modestly to $850, which means a total extra cost of about $3,540 over what you would have paid if you bought a year earlier.
Renewing Your Mortgage
There's definitely an argument to be made for buying a house now to lock in low mortgage rates, even though home prices are potentially at their peak. But then you will be in the position of having to renew your mortgage in a few years, when mortgage rates will almost certainly be a lot higher.
Assuming that's the case, recent buyers will be especially vulnerable because they'll be renewing at a point in their mortgages where they've paid off very little principal. Remember, the early years of your mortgage are spent primarily paying off interest.
Long-amortization mortgages of 30 or 35 years only make the situation worse. The 35-year amortization will disappear next month for people with down payments of less than 20 per cent, but it has been popular in recent years.
Maybe you bought a $333,000 house in the spring of 2009 and decided to pay it off over 35 years. You put 10 per cent down and ended up with biweekly payments of $629 by choosing a 3.5-per-cent rate over five years. If, on renewal, you went with a five-year mortgage at 5 per cent, your payment every two weeks could be almost $800. Over a year, the extra costs would top $4,000.
People who are further along in paying off their mortgages won't be hit as hard when rates rise, and they have more latitude to cope if higher payments become a problem by lengthening their amortization period at renewal. That's much less of a big deal if you have 12 or 15 years left on your mortgage than if you have 25 or 30 years to go.
I'm much closer to the end of the mortgage on our family home than the beginning, but I'm still planning ahead for higher rates. Here's what I'm doing to get ready. For each weekly mortgage payment over the past several months, we've been adding an extra $100 through what are known as double-up payments.
I arranged them online through my Web-based banking service, setting a start and stop date. It's an easy way to whittle down the outstanding principal in a way that will lighten our load if rates climb and help reduce our overall mortgage interest bill.
Pay down your mortgage or find a way to carve out some cash flow to pay for higher payments. That's how you fight the enemy of rising mortgage rates.
How higher rates can hurt affordability, even if housing prices fall.
3.90%: Cost of a five-year fixed rate mortgage
$344,550: Average house price in Canada at December 2010
$316,297: Amount to borrow if you bought the average house with a 10% downpayment*
$823: Accelerated biweekly payments amortized over 25 years
ONE YEAR FROM NOW
4.90%: Cost of a five-year fixed rate mortgage
$327,322: Average house price after a decline of 5% from a year earlier
$300,482: Amount to borrow if you bought the average house with a 10% downpayment*
$865: Accelerated biweekly payments amortized over 25 years
*includes mortgage insurance