This past week the Bank of Canada raised interest rates by another quarter point or 0.25%. That small change didn’t seem like much, but the Bank of Canada prime rate now sits at a measely 1.25%. Still low for historical reasons. The commercial banks followed suit with most major banks raising their prime lending rates to 3.45%. Again still historically really low. So should you be worried with the rate increases? What impact will that have on mortgages and housing?
The Housing Market
Everyone wants to know. Will the increases in interest rates and the B-20 changes coming into effect this year have a major effect on the Canadian housing market? It’s really still too early to tell. Some potential buyers that were not going to qualify this year may have locked in their interest rates over the next 120 days from the end of 2017 and thus have 3 months to close on a house. This might keep the market afloat for the first quarter of 2018, but what happens when April hits?
The spring housing market is traditionally the strongest for resellers. Last year, home prices in the frothy markets of Toronto and Vancouver were smoldering hot, this year it hasn’t started out too great. In other parts of Canada the market has been pretty dead for a while. Only the condo markets in Toronto and Vancouver continue to have any momentum and the detached housing sector is starting to show it’s cracks.
So just how much will the 0.25% increase have an impact on mortgage costs? Depending on how much the mortgage amount is and the amortization, the cost could range from anywhere between $30 a month for a $250,000 mortgage at 3.25% to $100 for a $750,000 mortgage if the amortization is 25 years. For expensive cities like Vancouver and Toronto this is the equivalent of having $20,000 less in purchasing power. Are the houses going to discount by $20,000? That all depends on how much appetite there is for real estate as interest rates continue to rise.
The bigger issue of concern for the real estate market won’t be the 0.25% interest rate increase, but the future hikes that could be coming. There are predictions that the Bank of Canada will continue raising rates throughout the year and into 2019. This could mean a significant decrease in purchasing power for Canadians. On top of that, Canadians that are renewing their mortgages in the future years will be in for a sticker shock. Remember when I said that the monthly payments for homes is as low as it will get? Well prepare to pay much more for the house coming soon. Don’t be surprised if mortgage carrying costs increase over $500 a month when home owners in expensive cities like Toronto and Vancouver start renewing their detached mortgage properties. Start saving now!
The Bond Market
The threat of higher interest rates have a direct impact on the bond market. If you’ve followed some of my posts on bonds, you should know that as the interest rates rise, the price for bonds actually fall. This is a standard phenomenon as yields on government bonds rises. Remember that a bond has a fixed interest on the face value and thus the only thing that can affect the yield is the price of the bond.
From the above chart, a standard Canadian bond fund is actually losing money as rates rise. This is normal and expected. Remember that bonds in any investment portfolio acts as a limiter. It limits the growth of your portfolio in some ways but it also softens the blow when markets crash. Despite the falling price, bonds are imperative in a balanced investment portfolio and should not be eliminated. Remember that bonds move inversely to the stock market. With the markets doing so well, there might be an urge to ditch bonds altogether. Don’t do it! This could all change if markets crash.
One key point to note about bonds is that as the price of the bond falls. The interest that the bond yields rises.
This means that if you hold bonds, have them DRIP. Make sure dividends are reinvested and that more shares are bought over time. This helps average down the cost of the bond price, but also at the same time you are averaging up the yield you are receiving from your bonds. Remember that when you buy fixed income assets, it’s for the long term yield, not the capital gains. If you buy a bond yielding for 3%, then by happy for that yield. Don’t worry about price fluctuations.
Loans And Credit Cards
Perhaps the scariest thing about rising rates aren’t the investment and mortgages, but the outstanding loans and credit card debt that Canadians have racked up. Just last month some polls were taken that showed that average Canadians owed $8,500 in debt not including their mortgages. That’s a whole lot of money!
With interest rates rising, the hit is immediate. Unlike mortgages that have locked in rates, credit cards and loans can move instantly with changes in the interest rate environment. That means monthly interest charges could start racking up for individuals that are having a hard time with their finances.
The study shows that the group most indebted are the 35-54 range. This core group of Canadians owe on average more than $10,000. A ridiculous number! No doubt these are the folks that have large mortgages because of high housing prices, children with high day care costs and the obligation to keep up with the Jones’. These people will start feeling the pinch more and might get themselves into more trouble if their debt is not resolved.
The worse group of individuals might come from those that have been using their homes as ATM machines.
HELOCs have become one of the most popular tools for banks to sell additional loans because home owners can use their home as collateral for the loan. On top of that, it’s taught by bank salespeople that using a HELOC is a great way consolidate debt into a lower interest rate, like paying off your credit card debt with HELOCs. This is the trap. It only makes people run up their credit card debt again because they are able to pay it off with gains from their homes.
The issue now arises now that with a slight 0.25% increase that mountain of a debt now requires more interest to cover. That means less money out of the pockets of homeowners and if these homeowners are already swimming in debt then there just might not be anything left that can save them except for selling their homes.
January started off with an interest rate hike. With the American economy firing on all cylinders and tax cuts to stoke additional inflation, don’t be surprised if the Bank of Canada continues to raise interest rates along with our neighbours to the south. That means it’s time to get serious about budgeting properly and paying off debt.
Cheap money is coming to an end soon. Even now the interest rates for loans are very low, but that won’t last forever. Eventually the rising of the interest rates will cause a reversal in the economy and bring about the bear market that everyone talks about. That means that it pays to get your finances straight. Don’t sell out your bonds even if they fall in price. Do the opposite and buy more! Keep to the path of financial prudence and understand that rising interest rates isn’t bad, it just means are economy is growing strong.