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Our regulators are right to be concerned about our record-high household debt levels, and more specifically, about the continued rise in Canadian mortgage debt outstanding.
With mortgage rates at record lows, everyone can afford to borrow more, and when ultra-cheap borrowing costs are combined with housing markets where there is much more demand than supply, prices rise quickly. Over time, rising prices and rising mortgage debt levels feed each other in a self-reinforcing cycle, especially in places like Vancouver and Toronto, where demand has outpaced supply for some time. The longer this continues, the greater the risk that borrowers will not be able to afford their mortgages at renewal.
To their credit, the majority of borrowers I work with are well aware of the risk that mortgage rates could be higher when they renew, and as part of our discussions, we often stress test their prospective loan to assess the cost of having to renew at a higher rate. To that end, in today’s post I’ll provide an example of what this analysis looks like in our current rate environment.
For starters, let’s assume that two separate couples are buying a property for $600,000 with a 20% down payment. (While I deal with Canadians from coast to coast, I originate most of my business in the Toronto area, so I’m using a purchase price and down payment that are typical of the first-time buyers that I work with.) This purchase would require a mortgage of $480,000, and if we assume a five-year fixed-rate at 2.29% that is amortized over 30 years, this loan would come with a minimum monthly payment of $1,842.
Now let’s assume that these couples adopt two different strategies when making their mortgage payments. Couple #1 makes only their minimum contractual payment over the first five years, while Couple #2 schedules an ongoing additional monthly payment, which lowers their effective amortization period from 30 years down to 25 years. To do that in this case, Couple #2 would need to schedule an ongoing additional monthly payment of $258, thereby increasing their total mortgage payment from $1,842 to $2,100.
Here is a summary of the key inputs we’ll be using, along with a comparison of the monthly payments and the balance outstanding at renewal: