Home prices in Canada are dropping but borrowing costs are snowballing. The inflation correction initiated by the Bank of Canada has led to five interest rate increases to date and the next announcement is scheduled for later this month. Although these interest rates have caused downward pressure on home prices in many cities across the country, the growing cost of borrowing means Canadians are qualifying for less when stress-tested. Some prospective buyers are trying to time the market and planning to enter when home prices dip another X%, but are rising interest rates the true culprit here?
Here’s How the Stress Test Determines What You Can Afford to Borrow
When a buyer wants to take out a mortgage, the lender will “stress test” the buyer. This process ensures that the buyer can afford the amount borrowed even if at renewal the interest rate has risen. In the case of a variable mortgage, it’s to ensure that if your monthly payment fluctuates, you’ll be able to afford it at its peak. To determine your qualifying rate, a lender will stress test you against current rates plus 2%. Today, the average fixed rate is roughly between 5 – 6.14%, depending on the lender.
The real estate industry is calling on the OFSI, the regulator of the stress test, to change the process and loosen mortgage qualifying rules to give buyers more purchasing power. However, there has been no word that the stress test will change, although the next review of the process is scheduled for December.
The Real Impact of Rising Rates
It feels like a bit of a chicken and egg scenario – buyers are hoping that as home prices fall affordability will increase, but we’re still expecting to see interest rates rise. Generally speaking, for every 1% that the stress test increases, buyers qualify for about 10% less for a mortgage.
So what does this all mean for what you can afford? According to Ratehub.ca’s mortgage affordability calculator, If you have a household income of $100,000 per year, a fixed-rate of 5% amortized over 25 years, you would qualify for approximately $416,000, assuming a 10% down payment and property taxes of around $5,000 per year. If interest rates were to rise another .5%, your affordability would dip down to about $390,000.
You Can Still Maximize Your Affordability
Building on our previous example, if a home price was $416,000 and interest rates rise by 1%, then the purchase price of our $416,000 home would have to drop by 9.9% in the same period to still be affordable.
The reality of the market is there is never a “right” time to buy, but there are steps you can take to prepare yourself and maximize your affordability.
- Secure a mortgage pre-approval: If you’re considering buying in the next four months, secure a pre-approval before interest rates rise again. It’s free, fast, and will ensure you are as prepared as you can be.
- Consider a variable-rate mortgage: If your budget allows for some flexibility, a variable-rate may help you save money in the long run as these rates tend to be a little lower. Currently, it’s getting more difficult to qualify for a variable rate but shop around with lenders to best understand all your options. You could also negotiate for a variable rate with a fixed monthly payment option to help establish more consistency with your household expenses.
- Pay off existing debts: If your debt service ratio is affecting your overall purchasing power, this might be the right time to create a financial plan to expedite paying down your debts.
- Save for a larger down payment: The more you put down towards a home, the less you have to qualify to borrow for a mortgage. If you have wiggle room in your debt service ratio, you may be able to use a home-equity line of credit or another type of credit to maximize your down payment.
Are you looking to buy or sell property? If you’d like, we can have a real estate expert show you the most efficient process that saves you thousands of dollars, a lot of time, with little or no inconvenience to you. Contact us today!