A word of caution on historic low housing interest rates
March 21, 2013
Our current historic low interest rates will prove to be the financial downfall for many Oakville residences. Despite the numerous warnings from Ottawa, those caught in the low interest rate trap will live to regret this period of their lives.
Taking on new debt and not paying down existing debt is like walking into quicksand. It might look safe but in this case looks are misleading. Your financial security could slowly begin to sink.
The problem is that interest rates are deceiving. You often don’t know what the future interest rate will be. That is the start of this dangerous cycle of carrying debt when interest rates are temptingly low.
You know the price for most of your purchases. For example, when you book a vacation, buy a suit, or order something online you know the price. This allows you to make an informed decision on whether or not to complete the purchase.
That is not necessarily the case with interest rates.
If you purchase a house in Oakville for $700,000, which is close to the average price, you determine whether you can afford the cost before you make that decision. The seller does not have the option to raise the price before your house closes. What is good is that you have secured the purchase price.
However, you will not have secured the mortgage interest rate during the 25 years it might take you to pay off the mortgage. Most mortgages last five years and current rates are listed just under three percent and can be negotiated lower.
If your down payment was $200,000 that would leave a mortgage of $500,000.Assume the mortgage rate is three percent. The interest component of your mortgage payments are $15,000 per year. You are safe for five years but for the next 20 years you are at the risk of being subjected to increasing interest rates.
When the mortgage is due you will re-negotiate and if rates have increased by just three percent that means the interest component of your payments will be close to $30,000 per year. Past rates have been well in excess of six percent. At this point we have no idea what future interest rates might be.
The large Canadian banks were recently promoting lower mortgage interest rates. Federal Finance Minister Jim Flaherty quickly cautioned them to not over promote the low borrowing costs to potential homeowners. He does not want a repeat of the real estate collapse that happened in the U.S. when too many borrowed to buy houses that they ultimately could not afford.
Our federal government along with the Bank of Canada has warned Canadians that household debt levels are at an all-time high and not to take on too much debt. These warnings should be considered.
The risk we face is being lulled into a false sense of security and being enticed to carry more debt than we can afford. Rates are low but virtually everyone agrees that those rates will increase down the road.
Never has the term “Buyer Beware” been more applicable to interest rates than it is today. We recommend extreme caution when committing yourself to long-term debt when you have no control over the potential cost of that debt.