When I was a kid, one of the things I learned from my mother was that interest rates are inversely correlated to housing prices. If interest rates are going down, then housing prices are going up.
Over the last 12 months, I’ve seen this lesson play out in real life. By the time this blog post goes live, we will have passed the one-year anniversary of the COVID-19 pandemic. Yet, there are cities in this country where the housing market is red-hot. People are tripping over themselves to buy homes and they’re “winning” bidding wars to do so.
Five-year mortgage rates in my corner of the world had been on offer for as low as 1.84% up until just recently. At the time of writing this article, they’re slowly creeping up but a few can still be found at just around 2%. The Talking Heads in the media are predicting that 5-year rates will increase steadily over the next year. They say that this will be due to the economy fully re-opening as everyone gets their vaccine.
Who am I to argue with the Talking Heads?
The corollary to my mother’s great insight is that house prices drop as interest rates rise. This is due to the fact that fewer people can afford house payments when the cost of borrowing increases. Fewer people buying is a fancy way of saying lower demand. Less demand for something forces sellers to drop prices in order to sell their goods. In the housing market, rising interest rates are very strongly linked to decreasing housing prices.
For the past 10 years or so, the interest rates for mortgages have been less than 4%. I can tell you that my very first mortgage – taken out nearly 20 years ago – was for 6.5%. That seems astronomically high by today’s standards! When I was teenager and working part time as a grocery store cashier, I worked with folks who were thrilled to get a mortgage at 8%. The super-low mortgage rates of the past decade have been normalized, and I worry that people forget that rates can also move in the other direction.
Two Minds
I’m of two minds when it comes to housing. Buying a house was a very smart move for me. I was fortunate enough to buy what I needed at a price that was less than 3 times my gross income. The mortgage payments were less than 30% of my take-home pay. I could afford the repairs and maintenance that come with a house. Taxes and insurance weren’t an onerous burden on top of these other costs. The monthly nut associated with my shelter did not inhibit my ability to invest for retirement, travel, and have a bit of fun with my family and friends.
In short, buying a house was a good move for me… 20 years ago.
Today, twenty years later, I’m not so sure that buying a house would be a good financial move for me. For starters, I would have to choose between servicing the monthly nut of homeownership and every other financial goal. My mortgage, property taxes, insurance, repairs & maintenance would render me house-poor for a very long time. There wouldn’t be room in my budget for things like retirement savings, travel, entertainment, vehicle replacement, or those little luxuries that make like easier. My financial life would revolve entirely around paying for my housing, and there would be no room for my other money priorities.
I used to think that renting was a bad idea. However, my perspective has become more nuanced. If renting allows one to have a balanced life, then I think it might be a good idea. Of course, that balance has to include maxing out all retirement savings and building an investing portfolio. Those investments need to be big enough to pay for rental accommodations when the paycheques stop arriving. Whether you own a house or rent your space, you need to pay for shelter one way or another.
Cheap rates aren’t here to stay.
Today’s very low 5-year mortgage rates will go up. Securing a mortgage at 1.84% is wonderful, but that rate is likely only going to be locked in for 5 years. (And only for those who were lucky enough to grab it!) At renewal, the rate might be 3.5% or higher. Can your crystal ball predict the future perfectly? Will your budget be able to survive the mortgage payment increase that will come with a higher mortgage rate? Are you positive that you’ll still have the same income that you have now?
Even if your job’s salary stays the same, will your other expenses do the same? I’ve noticed that the cost of my streaming service goes up every 18 months or so. The price of food hasn’t gone down, ever. Taxes seem to only ever move in one direction. The list goes on. Life gets more expensive every year, yet salaries and wages don’t always go up in tandem with the increased expenses of every day life.
So even if you were only of the lucky ones to grab a super-cheap mortgage rate for a five-year portion of your mortgage, I strongly urge you to calculate how much your mortgage payment will increase when you renew. It’s not too, too crazy to believe that the bond market will push the five year rate up by 50 basis points each year for the next five years. Add 2.5% to your current rate and see what your new payment will be. Can you handle it?
Alternatives
Your first option is to pick rich parents. It’s been my observation that some parents with an excess of money are willing to help their offspring purchase a home. Financially speaking, it’s wonderful to have that kind of help to get onto the property ladder.
Not all of us can pick our parents, so that means being a little more creative.
If I were starting out today, I’d be looking at becoming a landlord. Either I’d try to buy a house with a rental suite or I would have roommates. There would have to be someone else around to contribute to the mortgage payments. If my salary paid for the minimum monthly mortgage payment, then the tenant’s rent would be what I would use for the extra payments to principle.
Would it be ideal? No. Would it have to last forever? Also, no.
A third alternative would be waiting to buy. Like I said earlier, house prices will come down as mortgage rates go up. Figure out how much of a mortgage you can afford. This number will be different than what the bank says you can afford. After all, you’re the one who’ll be responsible for the payments so look at your budget and be realistic.
Once you know how much mortgage you can comfortably carry, open an account at EQ Bank and start salting that mortgage payment away. This benefits you two ways. First, you’ll get used to having a mortgage payment since you’ll have to make that payment once you’ve signed the mortgage documents. Second, this money will help you make as large a down payment as possible.
I’m not trying to dissuade you from buying a house. Truly, I’m not. I just want you to think long and hard about the financial commitment that owning your own home will entail.
In a world without pensions, I am not persuaded that it’s a good idea for a person to spend 25-30 years paying off a mortgage without the ability to save for retirement. A mortgage debt that leads to an extended hand-to-mouth lifestyle is rarely a good thing. It limits options and inhibits one’s ability to pursue their true dreams, goals, and desires.