Higher interest rates have cooled sales and starts in most real estate markets, they have wreaked havoc with top of cycle pre-sale contracts, and they have pushed half of all variable rate mortgages in Canada to their trigger point.
And yet Canadians continue to spend; on trips, travelling and eating out, despite the 425 basis points in interest rate hikes meant to slow down purchasing. Economic data published by RBC in February noted an increase in discretionary spending and credit card purchases in the first two months of 2023. Analysts observing our current ‘rate pause’ are predicting more tightening may be required.
Having enjoyed decades of low interest rate borrowing, homebuyers and homeowners saw a green light when the Bank of Canada reduced rates in April of 2020, with assurances they would remain low until 2023. Ignorant of looming economic inflation trends, Canadians took on unnecessary risk with almost half of homebuyers choosing variable rate mortgage products, while homeowners felt at ease accessing their equity through add-ons.
Real estate investors need to be aware, the Bank of Canada uses past data collected to make their decisions. They have no crystal ball or mandate to predict, but they do have a plethora of historical economic experience, which was missing from their misguided public prediction.
Seasoned borrowers remember interest rates topping 16% in early 1980’s, but most entering the real estate market today have experienced far different economic decades. In 1999 46% of homeowners in Canada had paid off their principal residence mortgage. By 2016 that percentage had fallen slightly to 43%, and in just the last 7 years has dropped to 34%.
This 20 year decline in outright ownership correlates to outstanding Canadian mortgage debt which has grown by 333% since 2003, in lock step with dramatic increases in property values, prices and access to home equity.
The messaging and lending products being offered to today’s homebuyers and homeowners are gift wrapped with direct access to spend up to 80% of their assets equity. Canadian homeowner equity was estimated at over 4.78 trillion dollars in 2021. Homebuyers and owners are targeted by banks and lenders with enticing online advertising and step-by-step videos explaining how to use their home equity to purchase a lifestyle they could not afford by income alone. In 2021 equity take-outs were expected to exceed $100 billion dollars, a factor that undoubtedly added to inflationary spending.
Taking out a mortgage is always a risk, reducing the equity position in your mortgage increases that risk. When you use home equity to pay for items that don’t add value to your property, you are gambling your asset will gain more in value than the equity position you reduce it to.
Once upon a time, we were encouraged to save money to make money. We paid for life’s little extras over a period of time by prioritizing, sacrificing and working very hard to earn the lifestyle you desired. You did not touch the equity in your home or property investment for any frivolous reason. That renovation, RV, or vacation purchase was achieved by hard earned savings + interest, or by borrowing against your equity, not depleting it.
Only if you experienced a catastrophic life or debt event, did you see your lender to borrow against your home equity with a second mortgage. Lenders faced with a client in financial crisis, are usually helpful in creatively consolidating debt to limit their risk that the mortgage will go unpaid. The danger lies in an unforeseen circumstance exceeding your debt to income ratio when you don’t have enough equity left to borrow against.
1.1 millions Canadians are set to renew their mortgages in 2023, and their equity position is one of the first risk indicators their lender will examine along with; income changes, credit card debt and credit score. Depleted equity makes you a higher risk to a lender and can be a factor in your ability to negotiate the best mortgage rates in subsequent renewals.
Property values and interest rates are fluid. We just witnessed the how quickly rates can rise and values can fall in a matter of months. That is why traditional mortgages offered 5 & 10 year fixed rate terms, allowing borrowers the ability to budget with low risk stable payments. There is a segment of homebuyers and investors with disciplined financial backgrounds that feel comfortable in managing their own wealth portfolios and home equity, and they do a great job in growing both. But for a great number of others, the temptation to access equity cash and lack of experience creates a risk of undermining your long term financial stability.
Don’t ever feel pressured to take on more risk than your are comfortable with when it comes to the biggest investment you will ever make. Making money takes action, keeping money is behaviour, growing money is knowledge. A strong equity position protects you, provides collateral, improves your rate options and overall long term financial wealth outcome.
Freddy & Linda Marks, 3A®Group RE/MAX Nyda Realty