"Nearly 1 in 4 homeowners say they'd have to sell their home if interest rates rise more, according to survey"
- CBC (link to article)
When you read the above headline and article, it might be shocking. Some would say it's reminiscent of a time when mortgage-backed securities failed in 2008. When loans were provided to those that don't qualify and no checks were done.
Or, and this might apply to those of us not in the two major centers, that infamous bubble bursting that we were all expecting.
Either way, if you look at the above article, the fact of the matter is we are heading into a mess of overleveraged homeowners that are reliant on the interest rates to remain low to stay afloat.
The survey that is referenced by Manulife Bank was weighted by gender, age, region, and education, which we would expect to be influenced by the two larger markets. Nonetheless, the problem can also be seen here in Calgary.
So we know the problem, overleveraged Canadians with mortgages too big to be affected by higher interest rates.
But how did we get here and what are some remedies we can learn to implement here in Calgary to avoid the same problems that are becoming more and more prevalent in the larger markets?
How'd We Get Here?
I've been in real estate for just over 6 years now and in all my time working in this great industry, it's always been what happens in Toronto and Vancouver finds a way to trickle down to our market.
However, one aspect of this that I feel hasn't really trickled down is how Calgarians treat our mortgages. Being of a very conservative province, we do treat our budgets and household finances in high regard.
Most clients I have the pleasure of working with hardly want to start their search at the max dollar amount they are approved for. They are very mindful of where their money is going and how it's being used.
More importantly, they are very wary of using their homes as ATMs if not needed.
I'm not sure if the same can be said with the two big centers. I hear a number of instances where clients are pulling out equity in their homes in the bigger centers to help with down payments for their kids. Or are using the exponentially grown equity to purchase other investment properties to take advantage of the appreciation.
The issue with this is when you start treating your home as an ATM, especially for items that aren't a need, but more of a want, you will overleverage.
And overleveraging leads us to where we have mortgages and secured or unsecured home equity lines that are so dependent on the interest rate.
When your income does appreciate but your home liability does because of equity is taken out, the ability to manage the debt becomes that much worse.
Now don't get me wrong there are instances where refinancing and pulling equity out makes sense. To reduce the cost of borrowing for example, so that you can get out of debt faster. But that also needs to be done in a responsible way.
I'm personally working with a client that is going through a reconciliation of debt that will increase their mortgage payment but also save them thousands in bad debt from car loans and credit cards.
But there are some that are in the larger markets, that are dealing with millions that are overleveraging their homes, to purchase pre-construction homes in Toronto that are 5 years out just so they can earn the appreciation and sell it when it's complete.
The fiscal responsibility is gone at that point to chance a profit that might never happen.
The Cheat Code
So what is the cheat code? How can we bring things in line that will allow Calgarians to not suffer this fate of solely relying on interest rates to keep their home?
Well, there are actually two cheat codes.
A household budget
The stress test
If we start working with both of these concepts in mind, there are ways to ensure your mortgage is causing you a burden to where you cannot handle it.
My wife and I started our budget about 10 years ago after we got married. In it, we had our incomes minus our expenses and it spits out how much we would have leftover (or be short - damn student loans!) at the end of the month.
Our budget has become much more complex over the years and we grew our financial literacy to where each dollar we earn is applied and accounted for.
The reason this is one of the cheat codes is that it shows you the playing field. It shows you where all the pieces are and what you can move or adjust to make the situation better.
When you know where the pieces are, you can adjust. For us, we had large amounts of student loans in the beginning and diverted our resources to make sure that was taken care of. Or another example would be when I started in real estate and my pay fluctuated, how we time our payments are critical for the kids' education, etc.
Know your budget, know the pieces and make each dollar work for you.
The Stress Test
Now when this policy first came out, it was highly unpopular, especially in Calgary. This imposed stress test of 5.25% (as of June 14) or 2% over the contract rates really hurt how much buyers could spend on housing initially.
I'm sure they are enjoying the fact that the stress test is there now.
This test has allowed homeowners to qualify for their homes if the rates were to be increased significantly (like they are now).
But just because you qualify at the stress test rate doesn't mean Canadians are taking the full advantage.
This is where it becomes the cheat code.
If you were to take your mortgage amount, apply the stress test of either 5.25% (variable currently) or 2% higher than your contract rate (fixed) and determine your monthly mortgage amount, could you still afford the other items in your budget?
If so, great you are ahead. That difference in the calculated amount and your actual mortgage payment can be put aside each month as a mortgage supplement savings.
If not and it would be tight, find ways you can adjust your lifestyle to make it so that a little bit can be used each month and work your way up. Just starting with a small amount will build the habit and grow.
As those funds accumulate each month, if and when interest rates rise, you are okay because it's already budgeted to increase. You take those saved funds and apply them to the increased mortgage payment.
But here is where it gets good.
If rates start to decline, say due to an accelerated recession, guess what, if you are on a variable mortgage, that amount you are saving is increasing while keeping your budget the same.
If you are in a fixed rate, your savings would remain consistent.
But guess where that payment gets to go?
Down payment for an investment property
That laptop you always wanted
Those renovations you have been having a hard time saving for
Paying down the mortgage faster by adding the saving to top-up payments of 15% to 20%.
and the list can go on and on.
And when the rates start climbing again down the road, you are able to mitigate it better. We can even talk about changing your amortizations at renewals to decrease the payment and keep more in savings.
It's A Process
Now I know what you might be thinking, this is all well and good in retrospect, but what can I do now that can help the situation?
The budget is a great place to start and there is a number of great apps you can use to make sure you are reigning in your spending. Personally, we use excel and just account for what goes in and out each month.
If you need to earn more, there are many opportunities for side hustles that can be used in the short term to help you get things on track.
Budgeting is not easy. The mechanics of it (the excel sheet, app, etc) are easy, but sticking to it is where it becomes hard. But if you are able to stick to it, get better at it, and apply the stress test savings, you will see great results to help your household not be so tied to external factors like interest rate changes.
I hope this breakdown was helpful for you and you were able to get some tools to help you navigate the constantly changing mortgage world we live in.
If you have any questions or would like to chat about your mortgage options, feel free to email me or set a time to discuss things with me below. I would love to help you get the tools you need to better understand your mortgage and potentially help you with products to better manage it.
Thank you once again for your time. Feel free to check out some of my other articles below, follow me on Instagram for more quick updates and join our newsletter for a monthly breakdown of the market and things to keep an eye on!