In short, the reason why the Bank of Canada increased interest rates is to slow the economy. In 2022, inflation reached a 39-year high of 8.1%. The way to tame inflation is to raise interest rates, as it discourages people from borrowing money. Because of increased borrowing costs, consumers purchase fewer goods, decreasing demand which slows business growth and the economy.
The past two years saw record-high sales in real estate. The low-interest rates and inventory created a vastly disproportionate supply & demand ratio. This frenzy caused house prices to surge as buyers threw offers at properties above list price with little to no conditions to out-compete others. High-interest rates have two effects on real estate: downward pressure on prices and increased supply as potential buyers are priced out of the market.
If your current mortgage rate is locked, rising interest rates will only impact you once your locked term expires (typically five years). However, if you have an adjustable variable rate, your monthly payments will increase as interest rates do. If you have a variable rate, more of your payment will go towards paying interest rather than paying off the principal, and your amortization period will increase.
Higher interest rates mean buying and selling homes is more difficult, and lower interest rates mean buying and selling homes are more manageable. We can use the example of “John ” to understand this concept better. If John purchases a $400,000 property at a rate of 4% on a 30-year fixed mortgage, his payment will be about $1,900. However, if John qualifies for a 5% rate, his payment will increase to $2,138. A 1% increase in John’s rate resulted in a 13% increase to his monthly payment, a total increase of $238. Therefore, as the interest rate increases, affordability decreases. If John qualified for a $400,000 mortgage at 4%, he would only be eligible for $355,000 at a 5% rate. His buying power decreased by $45,000 due to a 1% increase in interest.
Higher interest rates typically result in a decrease in the average price of homes. Interest rates also begin to decrease approximately six months after the last increase. With these points in mind, it may be a sound strategy to purchase a property while prices are low and then refinance to access a lower interest rate later down the road. Of course, this strategy only makes sense if you can afford a home at a higher interest rate.
Refinancing your home can significantly reduce your payments depending on your loan balance. However, you should be aware that refinancing will result in some upfront costs, variable depending on your financial institution. No matter what, however, you will have to pay a mortgage pre-payment penalty. This fee is typically equivalent to three months of interest or the interest rate differential, whichever is higher.
Time in the market trumps timing the market, significantly when investing in real estate (flips being the exception). Real estate will always appreciate in the long run; therefore, your decision to purchase a home should always depend on your ability to afford the payments and emergency funds for repairs, as Murphy’s Law would have it. When buying with high-interest rates, explore the option of paying down your mortgage with a higher down payment.
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