Title: Mortgage interest now biggest home ownership expense
Sub-title: Recent hikes mean that some Canadian home-buyers will pay more for mortgage interest than for their homes.
Financial planners have long noted the effect of mortgage interest rates on the housing market. For example historically low rates were in large part responsible for fueling the US housing bubble during that past decade, and for boosting prices here in Canada to historical highs. However mortgage interest rates have recently begun to creep back up.
During the past month alone, the major banks have raised their posted rates on five-year closed mortgages by a full percentage point. That may not sound like much. But as a result of the jump, some new homebuyers, particularly first-time buyers who can’t come up with large down payments will now pay more in interest costs, than they do on the actual home that they buy.
This week someone who puts a five percent minimum down payment on a $340,000 property, (the average price at which existing homes sold at last month in Canada) and takes out a five-year closed mortgage amortized over 30 years, at the major banks’ 6.25 percent posted rate, would have monthly payments of $1,994.92. Over 30 years, this buyer would pay $718,000 for his $340,000 home, of which fully $377,000 would be interest payments.
According to Bankrate.ca’s mortgage calculator (http://www.bankrate.com/can/mortgage-calculator.asp), that’s $73,000 more than the same buyer would have paid, had he taken out that mortgage one month earlier at 5.25 percent.
A non-deductible expense
A few caveats here. Yes of course not everyone pays the major banks’ posted mortgage rates. The banks will often significantly reduce those levels if you haggle a bit. If not, mortgage brokers will be glad to find you a better deal. However the major financial institutions’ posted mortgage rates continue to be a major industry bellwether, so it pays to pay attention.
Another caveat is that not everyone finances 95 percent of the purchase price of their homes, which means that not everyone will pay more in interest costs than they will on their actual properties. Using the above example, if the buyer put down a mere 20 percent on that new home, he would “only” pay $602,000 over the life of the 30-year loan. Those payments would include “only” $262,000 in interest payments, far less than the $340,000 purchase price of the home.
That said, the recent mortgage rates hikes signal that the economics of buying a new home have crossed an important threshold. At the very least, higher mortgage rates (which many expect will increase even further during coming months), imply that new home buyers need to consider how they finance their homes as much as they do its relative costs and benefits.
House price increases help ease the pain
During the past decade or so many new home buyers used rising house prices to justify mortgage interest payments that they made, a process that continues to this day. For example according to the Canadian Real Estate Association the average price of existing homes sold during March increased a full 17.6 percent compared to homes sold during the same month last year. Increases like that can finance a lot of interest payments.
That said, there is no guarantee that those price increases will continue. US home prices have fallen precipitously during recent years, and while few expect the same thing to happen here, economic observers ranging from CREA’s Gregory Klump to others at major financial institutions expect price increases to level off as the year progresses.
The other good news is that according to the results of a Canada Mortgage Housing Corporation survey released this week, 81 percent of recent home buyers are comfortable with the mortgage debt they are holding. In fact many respondents seem fully prepared to deal with the coming mortgage rate increases. More than two-thirds of them indicated that there was a strong chance that they would pay down their mortgages sooner than required.
If you believe the results of a recent report by two economists at Desjardins group, those recent home buyers are on the right track. According to Hélène Bégin and Jean-Michel Goulet, although housing affordability rose slightly in Canada during the first quarter of this year, the trend is unlikely to continue. “In coming quarters, things will get harder for first time home buyers and people who want to renew their mortgages,” the pair write. “As a result, the housing sector should lose some strength.”
That means a little prudence is increasingly in order for shoppers of new homes … and mortgages.
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