Of late, there is an enormous amount of news coverage regarding rising interest rates and inflation. And for good cause. The rising cost of food, gas, and housing are affecting us all. These necessities and their impact on our wallets bring home the message loud and clear. Interest rates are rising. Inflation is out of control. And how they are intertwined is a delicate relationship.
Inflation, according to the IMF, “is the rate of increase in prices over a given period of time”. In Canada, the inflation rate is measured by the Consumer Price Index(CPI). It creates a basket of goods which are divided into 8 major components: Food, Shelter, Household Operations, Furnishings & Equipment, Clothing & Footwear, Transportation, Health, & Recreation. In the last 25 years inflation has consistently been between 1-3% with a few spikes above and even a few spikes below. However, around January 2021 it began to rise and as of July 2022 it is at 7.6% with Shelter, Transportation & Food making up the top 3 contributors.
Why is inflation increasing?
Canada, and much of the world, are experiencing rapid price increases due to spending returning to pre-covid lockdown levels. Unfortunately, the rate of spending is fast outpacing the rate of manufacturing. Thus, demand is outweighing supply, causing prices to significantly increase.
To combat the drastic rise in prices, governments increase interest rates. Typically, as interest rates rise, people spend less and save more. As people spend less demand for products go down and as demand decreases so do prices.
What it means for the Halifax Real Estate Market?
The higher inflation is, the more we spend on basic goods like food and gas, which, in turn, reduces our disposable income. As household budgets are affected, some buyers are nervous to upgrade or purchase their first home. And as interest rates rise, the purchasing power of homebuyers decrease because higher rates mean larger monthly payments, thus impacting how much of a mortgage they can qualify for.
Interest Rates 101
The Bank of Canada (BOC) sets the overnight rate, which is the short-term interest rate that banks use to lend money to each other.
The BOC overnight rate is used to determine what banks & financial institutions use to set their prime rate. That prime rate is the annual interest rate Canada’s major banks and financial institutions used to set interest rates. All kinds of loans are based on it, including certain mortgages, car loans, lines of credit, and even some credit cards.
The actual consumer interest rate offered by institutions is directly tied to their prime rate. This rate can vary depending on the borrowers’ credit score and financial situation. As well as the banks’ financial goal of wanting to increase their mortgage or investment portfolio.
Canadians have been enjoying an unprecedented period of extremely low interest rates. Prior to March 2020, the BOC overnight rate was 1.75%. Shortly after, on March 27, 2020, the BOC took an extreme step and reduced the overnight rate to 0.25% to ease the economic pressure resulting from the COVID-19 lockdown. This decision led to substantially lower mortgage rates (as low as 1.5 – 2%) and encouraged consumers to spend during the lockdown. Even though, the Halifax market was already experiencing multiple offers per listing, the lower mortgage rates pushed it into an area not locally seen before.
In April 2022, due to rising inflation, the BOC raised the overnight rate 50 basis points (or .5%), from 0.5 – 1%. And has continued to raise the overnight rate to the current 2.5%. Experts are predicting further rate increases until at least the end of 2022.
Prime rates at the end of August 2022 are 4.7%.
To give an idea of what that looks like, picture this:
You purchase a $1,000,000 home with a 20% down payment. Resulting in an $800,000 mortgage amortized over 25 years. Depending on the interest rate, your fixed rate mortgage payment would be:
In the above example, if you made a $1,000,000 purchase when rates were at 2 – 2.5% your mortgage payment would be between $3388 – 3786. However, if you have just made a purchase, your monthly mortgage payment would be between $4208 – 4653. That’s at least $800 more per month, which directly impacts your disposable income.
How do Rising Interest Rates Affect Home Buyers
• Increased monthly mortgage payment. A 0.25% interest rate hike translates to an extra $13 per month per $100,000.
• Affects how much you can borrow. A higher monthly payment increases your total debt service ratio (TDS). Typically, lenders will limit TDS to 44% of your household’s income. Thus, what you could purchase when interest rates were at 2% will generally not be what you can purchase now at a higher interest rate.
• Sometimes lead to increase Buyer Activity. Aspiring homeowners with mortgage pre-approvals at lower-than-current rates are motivated to buy before their rate guarantee expires. And Buyers who expect higher interest rates in the future may choose to buy now while their carrying costs are lower.
• Sometimes lead to lower home prices, but they also lead to increased monthly cost. If you’re waiting for prices to fall before buying, be careful – it might end up costing you more overtime. So even though you may pay less for a property a year from now, it may result in a net-zero savings because interest rates could be substantially higher.
Pro Tip: If you’re thinking of buying in the next 12 months, get pre-approved and locked into a mortgage rate NOW. Nobody expects interest rates to decrease anytime soon (but if they do, you’ll still get the lower rate). Most mortgage pre-approvals are valid for 90 days, so you’ll probably need to repeat this exercise every 90 days until you buy.
How Do Interest Rate Hikes Affect Sellers?
Past interest rate hikes in Halifax have resulted in increased short-term buying activity (usually for a month or two), as Buyers with locked-in rates from before the hike accelerate their purchasing timeline.
BUT the biggest factor at play in Halifax’s real estate market right now is Buyer psychology. And buyer psychology is almost impossible to predict. If Buyers think rates will continue to increase, they may buy sooner rather than later to take advantage of today’s lower rates. However, they might also see an interest rate hike as a red flag and decide to wait, hoping that prices will come down.
How Does It Affect Home Owners?
If you already have a mortgage, please do not think that interest rate hikes won’t affect you. During your mortgage process, you made a few important decisions:
• Amortization Period (usually 25 years)
• Mortgage Term (typically between 1 and 5 years).
• Type of mortgage rate: Fixed or Variable
• Interest rate
At the end of your term, whether that’s 1-5 years, your mortgage will come up for renewal – meaning you’ll be subject to the prevailing interest rates. If current interest rates are higher than your old rate, your monthly carrying costs will increase. If rates go up significantly, some people may not be able to afford their homes anymore. Thankfully, the federal government introduced a mortgage stress test a few years ago to ensure that homeowners would still be able to afford their homes even at much higher interest rates.
Variable Rate Mortgages
Most variable-rate mortgages have floating or adjustable payments, meaning that the amount of your mortgage payment – increases or decreases – according to the bank’s prime interest rate. In today’s rising rates, that means your variable rate has increased and, unfortunately, resulting in a higher mortgage payment.
If you have a fixed payment variable mortgage, it means your payment doesn’t fluctuate with interest rates. However, the percentage of your mortgage payment which was paying down the mortgage principal will decrease. Resulting in more of your monthly payment paying interest rather than building equity. Thus increasing the time it will take you to pay off your mortgage.
Most variable-rate mortgages have the option of converting to a fixed-rate (meaning your rate does not change for the length of your term, and so the payment won’t vary when interest rates change). Historically, variable-rate mortgages have been cheaper, but if you think interest rates are going to continue to increase at a fast pace, you may want to consider converting to a fixed-rate mortgage.
Pro Tip: Stop trying to time the market. I don’t have a crystal ball, and neither do you. Do the right thing for you, whether that’s deciding to buy now, buying later, or deciding to sell.
How it all affects the Halifax market?
Interest rates are impacting our market. Multiple offers are occurring less and less. However, depending on the property and price, some properties are still receiving them.
Houses are staying on the market for longer periods. Some for over 60 days. However, in a normal market that is not unusual.
And price reductions are occurring more frequently, which, I think, you can expect to see more of. However, I think this is just the short term. Once inventories decrease, prices will stabilize. And if immigration/migration levels continue, plus rents rising, I think we can expect to see at the very least a stable real estate market and maybe even another hot period in the future.