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The Dangers of Your House Mortgage

The Dangers of Your House Mortgage

February 9, 2021

Low mortgage interest rates make home ownership affordable. When mortgage rates increase many homeowners will not be able to make the payments after their mortgage is renewed.

The mortgage on your house might be your most significant financial risk.

Normally when you acquire an asset, including a house or an investment, you hope for a strong economy. Your assumed logic is that will be good in supporting or increasing the value of your assets.

However, be very careful of what you wish for.

To illustrate this, we will assume a homeowner has a $1 million mortgage. Interest rates are very low, so we will assume the mortgage interest is 2%.

The homeowner will pay $20,000 interest annually. Plus, there will be additional payments that will reduce the amount of the loan, but for simplicity’s sake we will ignore that.

Now let’s focus on your risk.

The COVID-19 Pandemic has been devastating to many Canadians and businesses and without the incredibly generous handouts from the federal government, we could be facing economic ruin.

The government has done an excellent job at propping up the Canadian economy. Looking forward, it is anticipated that the economy will recover largely as a result of continued federal financial support.

So far so good. But here’s where it gets dangerous.

When the economy gets off life support and prosperity returns, we will start shifting into a period of higher inflation. The role of the federal government will change to controlling inflation.

To slowdown growth and fight inflation, the best financial tool available to the government is increasing interest rates. Higher interest rates will slow the economic activity and the government will be successful at managing inflation.

Back to the homeowner with a mortgage. Assume at the time of mortgage renewal interest rates have increased from 2% to 4%.

Suddenly the carrying cost on your house has doubled. Will the homeowner have sufficient cash flow to cover this increased expense?

 Peter Watson, of Watson Investments MBA, CFP®, R.F.P., CIM®, FCSI offers a weekly financial planning column, Dollars & Sense. He can be contacted through www.watsoninvestments.com