Higher Rates & Affordability

Affordability-of-your-mortgageBMO reports that 18% of Canadians “do not think they can handle higher payments” if interest rates go up. That’s a mite bit disconcerting.

“Higher payments” is a little vague, though. Does that mean those respondents cannot handle a $100 per month payment increase; or is something like $300 a month closer to their average breaking point?

We took it upon ourselves to clarify the exact question posed in the survey. 

It was:

To what extent do you agree with the following statement: ‘I would be able to afford my current mortgage payments if interest rates were to rise?’”

The nationwide responses were:

  • 67% strongly agree or somewhat agree
  • 18% somewhat disagree and strongly disagree
  • 18% prefer not answering or are unsure

Interesting…but the results would be a lot more telling if the question had referenced a specific interest rate increase.

People react quite differently depending on how high rates are assumed to rise. A 1/2% prime rate increase, for example, is a relative non-issue. A 4% rise, on the other hand, could put a slew of borrowers in financial distress.

For these reasons, this study doesn’t yield as much perspective as it could. But, it does remind us that some people need to ask tougher questions before jumping into a mortgage.

rising-ratesIf you’re refinancing or buying a new house, you have to ask things like:

  • “Can I afford at least a 3% rate increase (at renewal and/or during the term, if a variable rate)?”
  • “If I had to sell my home in a few years and the value dropped 15%, would I have enough equity to pay off my mortgage (or enough savings if I needed to cover a shortfall)?”

It’s hard to overstress the importance of financial breathing room. “Livin’ on the edge” may be a great Aerosmith song, but it’s no way to approach a mortgage.

More about the survey: BMO’s poll was completed on-line from January 17 to January 20, 2011 by Leger Marketing. The sample was 1,511 Canadians, 18 years of age or older. BMO states a probability sample of the same size would yield a margin of error of ±2.5%.

Rob McLister, CMT

  1. Affordability is also getting squeezed by price hikes in HST, electricity, gas, water, food, insurance, property tax, and other essentials. A 1% rate increase on a $100k variable loan works out to an extra $84 per month. I’d bet many families are already paying at least that much more for the aforementioned essentials than they were a year ago.

  2. I couldn’t agree any more with wjk. People seem to forget that among all the price hikes in commodities, wages have not kept up. Just over a year ago people and media included were in awe that gas prices hit over $1.20, however now that they have cushioned the blow the price appears to be a norm. I really hope our government and financial institutions are careful during this time, I believe there are a lot more Canadians that have taken on more debt during these low rates and continue to do so.

  3. With the recent affordability survey data, I think a 15% drop in home value would cause a huge increase in arrears and foreclosures.
    A home value decrease of 15% would cause forclosures for 11% of Canadians (who have less than 10% home equity according to the latest CAAMP survey). Unless they have alternate sources of savings to cover the difference. Scary!

  4. a foreclosure has nothing to do with equity in the home, its a simple “have you paid the mortgage bill in the last 6 months or not”
    My wife does foreclosures, and is constantly siezing houses with equity in it, the person gets paid out whats left after it sells and all debtors are paid out.
    And the only way your 11% number would apply is if
    They are selling and need to cover the shortfall
    they dont pay the mortgage payment for around 6 months.

  5. Agreed. Should a 15% correction occur (there was an article in the Toronto Star a few weeks ago that predicted an even more radical 25% decline), borrowers would be underwater as opposed to foreclosed. The situation in the U.S. is remarkably different. Over there, lenders were giving out mortgages to people who had zero equity in the property. When housing prices plummet and the teaser rate period came to an end, the borrowers simply walked away from the home figuring they have nothing to lose anyway.
    Consumers in Canada would be under pressure if inflation becomes a problem. For that to happen, energy prices must remain elevated and food prices would have to remain high as well. Since pay cheques here tend to stay the same and the debt-to-income ratio of many consumers is already at record highs (projected to hit 150% by the end of this year in contrast to 95% in the 90’s), default rates will increase heading forward, first on consumer credit followed by mortgages, especially once the Bank of Canada start raising rates which may come even sooner than current forecasts.

  6. >> a foreclosure has nothing to do with equity in the hom
    Not quite. Of course someone with negative equity can continue paying their mortgage, and someone with positive can default, but negative equity is the number two predictor of foreclosure (after unemployment) so they are strongly correlated.

  7. Brian you said: “A home value decrease of 15% would cause forclosures for 11% of Canadians (who have less than 10% home equity according to the latest CAAMP survey).”
    You cite CAAMP as a source of this statistic but I don’t recall CAAMP ever releasingg data on this. Can you please post the web link that confirms your claim?

  8. I stand corrected. My broker told me that if your renewing an underwater mortgage, you would most likely have to renew at the lenders posted rate. And you would be able to renew so long as you haven’t missed any payments during the term.

  9. I’m sure taxes are going to have to increase as well. Maybe not in 2011 but 2012, 2013 will be a much different story. Then there’s also pension reform and the all unfunded liabilities that will balloon even higher as the boomers age further. Justifying spending over 3.5 times income would be a fantasy for the average person.
    We may have not had 0% mortgages but we sure do have 5% cashback mortgages

  10. Historically consumers respond to household budget pressures by tightening their belts and making adjustments to their discretionary income. Keep cars longer, take transit, spend less on entertainment/holidays/clothes or delay unnecessary home repairs/upgrades or not contribute to their rrsp/savings.
    Rarely would a person stop paying their mortgage or get foreclosed without cutting back on their discretionary spending first.

  11. Brian:
    Rob’s story only states that 11% of people have less than ten percent equity. Where does it say that these 11% would go into foreclosure if house prices fell 15%? That is a wild exageration.

  12. Presumably people would have taken into consideration their belt tightening capacity when responding to the survey. I know I would have.
    Anecdotally, my brother went bankrupt a few years ago. To the end, he kept ‘necessities’ like his cell phone, cable, big screen TV, Starbucks runs, etc.. Tightening the belt’ clearly means different things to different people.

  13. Personally, as bad as I would feel for those I know who have bought recently. I welcome a hefty correction with open arms. As a young guy currently in the market for a home for a young family, I have learned a very real truth. Easy lending breeds poor negotiators. Looking at a dumpy 1 (advertised as 2) bedroom bungalow in a lousy neighborhood, with a slimy real estate agent attempting to justify why the 350K is a “great deal because prices are still rising” is very, very, discouraging. I wish no bad to anyone, but the sorry lemmings who know only to ask “what’s my monthly?” with no comprehension of what true value is, have dug a financial grave that I don’t want to step foot in. I have decided to stand back, and eagerly await the payment for these foolish mistakes. My parent spent 40K on their home when they were my age. Their salaries looked similar to ours. They paid less for cars, insurance, food, utilities, etc etc. And tell us endless stories of “hard times”. Somehow, I just don’t feel bad for them when I see all the “investments” they are unloading on the younger generation for exorberant prices. But Due Diligence says, it’s my generation to blame, for being so stupid as to pay it.

  14. Considering your outlook waiting is likely a good choice for you.
    Just make sure you’re willing to stick to your guns as the oncoming price decline will be very very slow process lacking eye-catching price declines.

  15. I think it’s absolutely comical, that every “Young buyer” think they can predict housing price trends, in a fiat currency, with such specificity. It’s like the under 30 crowd, of “young buyers”, never even purchased a home, think they can out smart the market.
    How many people trade their first stock successfully?
    Real-estate is no different than any other asset class. Timing the market, is BRUTALLY hard, and in the long run more a function of luck.
    I’m just saying, give up, trying to predict it, especially in a fiat currency environment.
    A dollar is only worth a dollar, because the government says it is. That why they can sell $8 worth of silver, for $20 at the mint.
    The long run average for the price of the average family home in Toronto, is about 6700 barrels of oil. This is what the price will oscillate around, because that’s where the marginal supply is.
    What that number will be in loonies is a waste of time to even discuss.
    Step away from the fiat,
    Jeff M

  16. A 15% decline in Average Toronto Family Homes, in one year, is a 2.24 sigma move. 25% would be a 3.29 sigma move.
    2.24 is a 1 in a 79 year event.
    3.29 is a 1 in a 2000 year event.
    The volatility, just isn’t in the Toronto Star’s favour.
    Of course, one might say, well a 25% move might happen over 2 years. But over 2 years, a 25% drop, is still a 1.97 sigma event. 1 in 40 year event. Considering the fact that we just had 3.05 sigma, 2 year move to the upside in 1987, and even that didn’t bring a 1.5 sigma move to the downside a over the decade to follow, I’m having trouble believing the 1 sigma moves to the upside over the last decade could possibly bring about a 3 sigma move to the downside.
    Of course, anything can happen with socialist voters, living next door.

  17. FYI. Calling people slimy won’t win you respect or credibility.
    $350K isn’t a bad deal if prices go to $400K, $450K, $500K…. I’m not saying they will anytime soon, but who’s to say they wont?
    On a separate note, if your parent’s salaries over 20 years ago look similar to yours today, then I’d suggest finding better work. Look for an employer that indexes your wages to inflation and pays you more, like McDonalds.

  18. Check out the interesting and relevant news tweet on “The avg bankrupt”.
    The ingredients for bankruptcy are a) high debt loads, b) high interest rates, c) personal disaster.
    Many already have a). With the average marriage lasting only 7 years and other facts of life, everyone will have c) sooner or later. Only b) remains largely absent thanks to artificial, government subsidised, “émergency” rates. How long will that last?

  19. Why the double quotes around fiat loonies? Are you implying the loonie is not fiat? Whatever you’re inferring, it is lost on me.
    And you’re wrong, most people aren’t paid in fiat loonies. Yes, most Canadians are. Most people on earth, aren’t. Lots of immigrants come here every year, with life savings, in other currencies. Most of them fiat. You can say this segment of the market doens’t matter – but I think they are closer to the marginal buyer than the average Canadian is. I can’t prove this, I am only speculating.
    Fact: It takes energy to build marginal supply.
    Fact: Cost of new supply, will never be lower than the price of energy it takes to build it.
    Fact: Energy is rising in price.
    Corollary: Housing prices will remain correlated with energy prices denominated in fiat.
    -Jeff McLarty

  20. Maybe I didn’t make myself clear. It’s fascinating that the price of an average family home in Toronto has consistently been about 6,700 barrels of oil. But that doesn’t make it a “waste of time to even discuss” (your words) because people who work in Toronto are paid in dollars, not barrels of oil.

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