As Realtors, we are certainly thankful for the resurgent real estate market Canada-wide. Low interest rates have been instrumental in increasing affordability to entice first-time buyers into the market. Real estate is local so let's look at a typical scenario in Kitchener-Waterloo. A couple buy a detached home for $250 000 with 5% down and get a 4% mortgage with a 5 year term amortized over 35 years. Their monthly payments are $1079.88 on a $244,981.25 mortgage(insured). The balance at the end of 5 years is $227,095.53. Despite the extended amortization, they have managed to pay off almost $18,000 in principal. So far, so good!
Recently, I saw a chart showing the average interest rate for June since 1951 was 9.08%(not including 2009). Let's assume, in the example above, the days of "cheap" money don't last forever. At renewal, the couple are faced with a 5 year interest rate of 8% and keep the 35 year amortization. Monthly payments rise to $1599.55 for an increase of 48%. The balance at the end of the second 5 year term is $219,610.68. Under this scenario, the amount going toward principal is roughly $7500 inspite of paying $95,973 over the 5 years.
Barry Lebow is an appraiser with Lebow, Hicks Ltd. in Toronto and a man for whom I have a great deal of respect http://lebow.ca/BarryLebow.pdf . He was recently quoted in the Toronto Star saying "There are going to be tremendous changes in real estate. There are just not enough first-time buyers and the ones buying today, those people are not really buyers. You know what they are? They're renters of cheap money, variable-rate mortgages of 2.99%. If mortgage rates were 8 to 9%, these people wouldn't be buying. It's an artificial market. One hiccup in the rates and it's all gone."
In my next post, I'll detail strategies designed to protect yourself in the coming years.