As far as home values are concerned, affordability to make mortgage payment is a great leveler.
Any significant hike in mortgage payments would actually bring down prices of homes and the other way around. Considering this connection and the current soaring home prices, affording to make mortgage payments is important.
In order to learn about the precise worries of this threat, we have consulted Sal Guatieri, senior economist at BMO Capital Markets. Below are some points you may take into consideration.
BMO says an average buyer can afford owing a home when the costs of carrying a mortgage are with 39 per cent of the earnings of the family. The current national average is 31.6 per cent.
According to BMO, as much as 28 per cent of the average family income is spent on paying the mortgage of a standard priced house, provided the buyer did not receive any discount on mortgage rates. This drops to 23 per cent if you buy a house outside Toronto and Vancouver. Earlier, these figures were higher - 44 per cent and 39 per cent in 1989 and 2007 respectively.
Defining what is 'normal', it can be surely said that the current 'normal' is lower compared to the earlier 'normal' owing to declining domestic growth rate and Bank of Canada's measures to control inflation. In order to enliven the economy, the bank has maintained the overnight rate of the country at only 1 per cent for 902 days at a stretch. Guatieri says that considering the roughly 2 per cent inflation target, a normal overnight rate ought to be roughly 3.5 per cent.
This means rates should tentatively rise by roughly 2.5 percentages for short-term rates and, as a result long-term rates ought to rise too, driving five-year fixed mortgages to anything close to 4.99 per cent. Other things remaining same, the fresh 'normalized' rates would raise carrying costs of mortgages to 37.2 per cent of total earnings from the current 31.6 per cent.
However, the soaring interest rates do not pose a severe threat, because eventually the rates will rise when the economy of Canada strengthens, resulting in higher earnings for the households. This will counterbalance the negative effects of escalated rates, if any.
Guatieri says that the domestic income should go up by 19 per cent to completely counterbalance the effects of 2 per cent rise in interest rates. Considering the current growth rate of 3 per cent, this may be feasible in another six years. A rate shock or severe joblessness problem may do a major damage to affordability, he added.
While Guatieri admits that predicting a rate shock is difficult, RBC noted that they suppose that the BoC will not change its overnight rate in 2013 and hike it slowly from early 2014. Therefore, there is less chances of the threat being a reality in the near future. In fact, affording to make mortgage payments is not a key issue and will neither become one even after normalization of interest rates, he opines.