Low Interest and Mortgage Rates Incentivize Buyers—But What About the Future?

Homes are pictured in Vancouver, in a file photo. The Canadian Press/Jonathan Hayward

News Analysis

Anticipation of higher interest and mortgage rates in 2022 provides an incentive to buy now, although concerns remain about affordability of mortgage payments once rates go up in the future.

The Bank of Canada has indicated that it will raise interest rates as early as the second quarter of 2022. An economic study by Desjardins, released Dec. 20, suggests that “very gradual” annual increases of 0.5 to 0.75 percent will be coming. Mortgage rate hikes are also expected, though variable rates have a more direct relationship with interest rates than do fixed rates, which tend to follow bond yields.

Carleton University business professor Ian Lee, who sold mortgages at one time, says consumers may be smart to get mortgages before interest rates rise, noting that it might be even better to lock in fixed rates. However, he warns that plans don’t always pan out and may lead to consequences, as experience shows.

“If it’s a 2 percent premium to go from the floating variable rate to the five-year fixed, you’re assuming that in five years those rates are going to go up even more than the 2 percent that you’re paying extra for doing a five-year fix,” Lee said.

“It’s a gamble,“ he acknowledges. ”But I don’t think it’s a crazy gamble, especially at this unique time in Canada’s history and [that of] the U.S. and the world, because rates have never, ever, ever, ever historically been this low.”

The gamble has been taken by many in recent years. According to credit bureau TransUnion, mortgage debts grew 45 percent from Q2 2019 to Q2 2020 and 49 percent from Q2 2020 to Q2 2021. The average mortgage balance has also grown, averaging $286,669 in Q3 2020 compared with $314,260 in Q3 2021.

Lee remembers taking out his first mortgage in the 1970s before a long period of interest rate hikes. He says his mortgage payments grew substantially at renewal time.

“When it came up for renewal, I locked in at five years. Why did I do that? Because I knew inflation was going up, house prices were going up, interest rates were going up, because my wages were going up. And I figured I was going to win in the sense that my wages were going to roughly equal or be even better [than the] rate increase on my mortgage. And lots of people made that gamble of my generation—the boomers—and it worked out very nicely,” Lee said.

“It hurt. ... I had a whacking big mortgage, and it renewed 2 percentage points higher. Well, if you have a big mortgage over the maximum period of time and it goes up two points, believe me your mortgage payment goes up very significantly.”

History may repeat itself for current homebuyers. A June 2021 study by Desjardins suggested that a five-year fixed mortgage rate could gradually rise from a currently posted rate of 4.74 percent to as much as 6.95 percent by 2024, while prime rates could rise from the current 2.45 percent to as high as 5.2 percent by 2024. Both increases outpace the 2 percent stress test applied in mortgage approvals.

Even if rates stabilize after 2024, these increases would still hurt. A $500,000 fixed-rate mortgage with a five-year term and amortized for 25 years would see monthly payments rise $653, from $2,834 now to $3,487 by 2024. A $500,000 variable-rate mortgage at exactly the prime rate and based on the same term and amortization would see monthly payments rise $767, from $2,227 to $2,994.

‘More Buyers Than Sellers’

Years of low interest rates have not decreased the household burden for housing. According to Bank of Canada data, households’ mortgage debt service ratio—the share of disposable incomes spent on mortgage payments—went from 5.39 percent in 1990 to 6.51 percent in Q2 2021, going up more than one percentage point.

The central bank also found that “when interest rates fall, many households simply adjust by borrowing more.” The ratio of mortgage debt to gross GDP rose from 38 percent in 2000 to 71 percent in Q2 2021.

When interest rates return to historic norms, new homebuyers will be more burdened by mortgages than they have been in decades. Another risk is that, if the current low interest rates have driven up demand for housing and pushed up prices, the reverse could occur as interest rates rise, deflating home values for those stuck with big mortgage payments.

Lee says that such risks are not as strong as they might appear because higher inflation will drive up wages and make those big payments easier to handle. He adds that mortgage holders probably won’t be stuck with a depreciating asset, since higher wages and more immigrants will ensure high demand and keep home prices high.

“What’s driving house prices is not speculators. It’s not people walking in anticipation of a rate increase. It’s because there’s a fundamental mismatch or shortfall. We’re not building enough houses. In plain English, there’s more buyers than there are sellers,” Lee said.