You know how the housing market rebounded so fast and furiously after its recent downturn?
The same thing could easily happen with interest rates, which are now close to historic lows. That's why there is growing concern the homes being snapped up today could become unmanageably expensive when mortgage rates rise.
The cost of carrying a mortgage will absolutely shoot higher in the next few years. Nothing is more certain, so let's get you prepared.
According to Michael Gregory, senior economist at BMO Nesbitt Burns, a "normal" level of interest rates would suggest a cost in the area of 6 per cent for variable-rate mortgages. "We're at about 2.25 per cent for variable-rate mortgages today, so we're looking at a potential rise of close to four percentage points over the next five years."
Mr. Gregory said rates typically move in such a way that the cost of a five-year, fixed-rate mortgage would rise about two percentage points in this same outlook. So if you take out a five-year mortgage today at a rate of 4.5 per cent, you might expect to pay 6.5 per cent at renewal.
These are estimates only, of course. Actual rate increases could be less than this, or more severe. What's certain is that rates will rise.
"The Bank of Canada has been very clear on this," Mr. Gregory said. "'Ladies and gentlemen, rates are abnormally low and in the future they're going to be higher. So be careful.'"
Economists at Scotia Capital say the risk posed by rising mortgage payments is compounded by the growing preference for 30- and 35-year amortization periods rather than the traditional 25 years, and by a trend to small down payments. On the cusp of a big runup in mortgage rates, people are borrowing more and taking longer to pay what they owe.
True, the kind of economic growth that prompts large rate increases should also allow employers to increase paycheques for their workers. Your salary could be somewhat higher by the time you face increased mortgage costs, but so will the general cost of living. Bottom line, you need to think about how you'll afford higher mortgage payments.
If you're in the market for a house, start by capping the amount you borrow relative to your income. Lenders will allow the cost of your mortgage, home heating and property taxes to eat up as much as 32 per cent of your gross income, and they're okay if all your debts account for 40 to 42 per cent of your pretax income.
Vince Gaetano, vice-president at mortgage brokers Monster Mortgage, said he recommends that customers allow their mortgage, heating and taxes to account for no more than 28 per cent of income, and that total debts should top out at 38 per cent.
"Yeah, you may qualify for more," he said. "But do you want to increase your mortgage payments?"
Five ways to prepare for higher mortgage rates:
Scotia Capital economists say their concern is the majority of home buyers who are choosing floating rates and setting themselves up for "gradual and material rate resets" over the next two years.
The way to insulate yourself against rising costs in a variable-rate mortgage, Mr. Gaetano suggests, is to set your payments at a higher level than you need to. Your lender is offering a variable-rate mortgage at 2.25 per cent? Then ask to have your payments calculated as if your rate were 4.25 per cent or 5.25 per cent.
"You're paying down more principal that way and, if rates go up, your payments won't change because you're already paying more," he said.
You'll see the benefit of this strategy when you go to renew your mortgage and you find that the amount you still owe is lower than it would have been otherwise. By increasing your accelerated biweekly payments by $100, for example, you would chop close to $14,000 off the balance owing at renewal time on a $250,000 five-year, variable-rate mortgage.
For Mr. Gaetano, the threat of rising rates makes this the ideal time to pay down as much of your mortgage as possible, through either increased regular payments or lump-sum amounts. "If you can halve what you owe before interest rates double, your payment in interest costs will be the same."
If you can't pay down your mortgage, see how much you'll owe at renewal time and then project what the monthly payments will be if rates rise. Maxed-out borrowers will have roughly six months to a year to before things start to get tense.