Rising interest rates are across the news, presenting a seemingly daunting scene for seasoned real estate investors and those considering investing for the first time. It's true the pre-construction real estate market in Ontario looks strikingly different from that of just a year ago. What’s fascinating is that Canada's interest rates remain at all-time historic lows. Is now the perfect time to invest? It certainly could be.
Rising mortgage rates shouldn't incur anxiety. We believe every homebuyer should know how interest rates affect the housing market, who sets the rate, and how you can take advantage of today’s pre-construction market.
Yes, interest rates remain at an all-time low.
As a result of rising interest rates, many pre-construction investors and homebuyers have pulled back from the market to wait things out. But it's important to remember the bigger picture.
A mortgage lasts for 25 to 30 years and rates will go up and down throughout this entire period. The average 5-year conventional mortgage rate for the past 30 years has been at 6.46%. Knowing this helps prepare you for what you will most likely be paying for your mortgage throughout your entire lifetime. Today’s rates continue to be very low compared to the average mortgage over the past 30 years. This is something to consider when doing your mortgage math. Check out these key facts:
Interest Rate Highs
- The Canadian Bank Rate was at an all-time high in 1981 of 17.93%.
- The 5-year conventional mortgage rate was at an all-time high in 1981 of 18.38%.
Interest Rate Lows
- The Canadian Bank Rate was at an all-time low in 2009 of 0.65%.
- The 5-year conventional mortgage rate was at an all-time low in 2021 of 4.79%.
Why were rates so high in the 80s? The early 1980s were full of runaway inflation, with baby boomers entering the labour force, oil prices spiking, and high wage demands pushing rates upwards.
Today, we have a much different scene. In 2022-2023, mortgage rates rose, but they remain far from the 18% rates witnessed forty years ago.
Will interest rates rise again to meet unprecedented levels? This remains to be seen, but right now, we can say that we're witnessing the continuation of an abundance of attractively low rates.
How do interest rates affect homebuyers?
Typically, common knowledge states that buying or selling a home can be more difficult when interest rates rise. Conversely, this can be easier when rates are decreasing. But there's more to it.
Let's look at an example. If Sue obtains a 4% rate on a 30-year fixed mortgage for a home valued at $400,000, she must pay a monthly mortgage of $1,900. In contrast, if she qualifies for a 5% rate for the same timeframe, her monthly payment would rise to $2,138. You can see how a rise of just one percentage point increases monthly payments on a mortgage considerably, in this case, by $238/month.
Generally speaking, as mortgage rates go up, affordability goes down. In Sue's case, when qualifying for a mortgage at 5% instead of 4%, lenders can only offer her a $355,000 loan. This decreases her purchasing power by $45,000, compared with a loan at 4%.
But consider this. When interest rates rise, housing prices most often tend to fall. This is happening right now across the Greater Toronto Area (GTA). We did some research to find out how this can affect investors' profits and the news might surprise you!
We found a home listed on MLS in the GTA that sold for $1.25 million in February 2022. The buyer, (Buyer A), paid 20% down and obtained a mortgage for $1 million at a rate of 3%. Their monthly mortgage payments now amount to $4,742.
We then found a home comparable in size, features, and location that was purchased much more recently. This home was pretty much exactly the same as the first. Due to lowering housing costs it was purchased by Buyer B for just $875,000. The buyer obtained a starting mortgage of $700,000 at an interest rate of 6.5%.
Interestingly, even with rising interest rates, both Buyer A and Buyer B had monthly mortgage payments that were almost exactly the same. (Buyer B now pays $4,726 per month). And it gets even better.
We created a scenario and imagined both buyers decided to sell their homes after owning them for five years. Keep in mind, interest rates in Canada are predicted to rise in January and March of 2023 and to then hold steady. Experts are further predicting rates will then start a slow decline by the end of 2024. This will most likely push housing prices back up.
In light of this, we found that if both Buyer A and Buyer B were to sell their homes for $1.5 million apiece after five years, Buyer B would make a considerably larger profit. This is true even though they bought their home while interest rates were higher. Buyer A would make a profit of $394,945 and Buyer B would profit well over $600,000. The takeaway? The age-old saying to buy low and sell high still holds true.
Falling housing prices can help mitigate the effects of rising interest rates in the real estate market. When houses are selling at lower prices, and interest rates are expected to go down in the near future, this can potentially present the ideal scenario for investors to profit. Now could be the time to make your move!
Who sets the key interest rate?
The Bank of Canada sets the key interest rate. The key rate is the rate at which banks are permitted to borrow money when they fall short of having enough funds in their required reserves. This process of setting the interest rate started in 1935 when the Bank of Canada was founded and how the key rate has been set has varied over the years.
Since 1996, the Bank Rate has been set to match the Bank's own target for the overnight rate, which is the rate banks charge each other when lending money among themselves. This is considered a good indicator of what's happening within monetary policy.
By 1999, the target for the overnight rate came to be defined as 25 points below the Bank Rate.
Of course, it isn't news that investors don't like surprises. Since 2000, the Bank of Canada introduced a system whereby changes to the official interest rate are announced at eight fixed, pre-specified dates throughout the year. The Bank of Canada did this to help keep inflation on track, everyone informed, and render necessary changes less staggering to witness.
Will interest rates continue to go up in 2023?
The key overnight lending rate rose seven times in 2022 to tame rising pandemic inflation. It increased to 4.25% in December 2022 and we predict it will go up again by 25 basis points on January 25, 2023 and by the same amount on March 8 when official announcements are made by the Bank of Canada. While the future isn't set in stone, industry experts predict that, following this, interest rates will likely hold steady throughout the entire year, which is positive news for investors.
The role of a strong economy
Rising interest rates certainly have a notable effect on mortgage rates, consumer loans, property value, and housing prices. But, how does the health of the economy play into all of this?
If the economy isn't growing to match the rising interest rates, trouble can ensue. When the economy is growing fast enough, however, in theory, employers will be able to raise salaries to match these rising rates.
So, in Sue's example, her salary increase would allow her to easily cover the additional $238/month presented by her 5% mortgage rate.
When wage and job growth can match rising interest rates, the housing market can continue to move forwards and won't be immobilized.
A Buyer's Market versus a Seller’s Market
You have likely heard the terms “buyer’s market" and “seller’s market". What do they mean? A buyer’s market occurs when there are more homes for sale than people interested in buying them. In comparison, a seller’s market occurs when there are more potential buyers than there are houses for sale.
How rising interest rates can help condo buyers
Rising interest rates do bring one great advantage. As mortgages become more expensive, fewer people will decide to buy, and the demand for homes will decrease. Once this happens over time, and there are fewer buyers in the market, sellers will lower their prices in an effort to attract more potential buyers. It’s all part of the give-and-take of the real estate market.
So, while rising interest rates might make buying a home seem unattractive, remember rates are still at historic lows. Now is the best time to be on the lookout for optimal pricing that could play in your favour.
What’s better? Lower interest rates versus lower closing costs
Everyone's particular situation is different. To determine whether it's better for you to have lower closing costs or a lower interest rate, do the math. The exact numbers will point you in the right direction. Ask yourself, what results in the total overall purchase of my home being at a lower cost?
Because you pay interest over a long period of time, usually a lower interest rate will be the better way to go if you don’t refinance your home, but this can depend.
Seek out perks and incentives when buying a condo
It’s key when purchasing in a buyer’s market to consider negotiating extra perks. Aim high! Now is the best time to leverage your side of the deal for a preeminent outcome. Builders need to attract buyers in any way possible when interest rates are rising and with this comes your chance to obtain an even better edge.
Perks known to now be on offer from select developers in the GTA include:
- Special preview pricing
- An extended deposit structure
- Capped development charges and levies
- 0$ development charges and levies
- Free assignment, (the right to sell before taking possession)
- The right to lease during occupancy
- Only 15% down until occupancy
- Only 10% down until occupancy
- $10,000 credit on your closing fees or 1 year free maintenance
- Discounted parking and locker
- Free parking spot
- Free locker
- Free window coverings
- A free island for any three-bedroom unit
While these incentives may or may not be available from your developer, it can be worth making the effort to inquire. Chase incentives that place more money in your pocket and make your condo even more appealing to future buyers.
Canada’s economy remains strong and we continue to experience some of the lowest interest rates on record. As an investor or homebuyer, now is the time to seek out lower housing prices and to negotiate for the best purchase possible.
As more people move to Canada the need for housing will only grow stronger over time. Data shows we’re already behind on creating enough housing supply to match Ontario’s projected needs and housing prices will inevitably go up. To learn more about investing in the GTA condo market and reaping the rewards of homeownership or real estate investing, click the link below.
- When the economy is growing, interest rates tend to rise leading to higher mortgage rates.
- Higher mortgage rates make homes more expensive for buyers, thereby reducing demand.
- Reduced demand leads to reduced home prices in order to attract more buyers.
- Buying now while housing prices are lower and reselling within a few years can potentially bring large profits.