Interest rates are always a topic of discussion both inside and outside of real estate circles. Whether the real estate market is up, down, or moving sideways, prevailing rates will always play a role and always have an impact.
While interest rates are going to determine a buyer’s affordability, and to some extent, help shape the overall market that buyer finds him or herself in, there’s much more to the journey of purchasing a home than interest rates.
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The biggest mistake that a prospective buyer can make is too pay too much attention to interest rates and not enough attention to a host of other factors that go into the decision of what to buy, when to buy, where to buy, or whether to buy at all.
To put this in the proper context, allow me to offer five things to remember about interest rates when beginning your housing search.
1) Remember that price are low when rates are high, and rates are high when prices are low.
Real estate prices typically rise when interest rates are low, and this is a simple function of economics.
When rates are low, affordability increases. This means not only can a buyer qualify for a larger mortgage but more buyers can qualify overall. So increasing the amount of money that can be borrowed by the buyer pool as well as the number of buyers is going to increase demand significantly.
In that same market cycle, unless the overall supply is increasing at the same rate (which it typically would not), then prices rise accordingly.
It’s the most basic example of supply and demand working in a free market.
Supply remains the same. Demand increase. Prices will increase as well. Voila!
But when interest rates begin to increase, it would theoretically reduce the buying power of the average buyer, and thus remove some buyers from the market.
When we saw a period of interest rate increases introduced by the Bank of Canada in the spring of 2022, buyers left the market in droves. Part of this was due to decreased affordability, but some of this was simply due to the psychology of buying into a market with increasing interest rates.
So what does this mean?
Do you only buy in a low-interest rate environment?
Of course not!
It’s about perspective. It’s about planning ahead.
If prices are down when interest rates are high, then the “smart money” will buy at depressed prices, take a short-term hit on the higher interest rates, but ride the appreciation on the way back up – and return to lower interest rates in the near future.
Not everybody has that option, of course, but that leads into our second point to remember.
There are so many things you need to consider when buying a home. Here are some more blogs you might find helpful:
- What Not to Do Before Buying a House
- Is It Better to Buy a Home First or Sell First?
- How to Choose the Right Type of Mortgage
2) Interest rates determine affordability.
To suggest that nobody should buy a home when interest rates are high ignores the fact that all buyers are different.
Some buyers have a higher risk tolerance than others and can buy into a depressed market with higher rates, in order to take advantage of a “dip.”
But for most buyers, the interest rate is merely there to determine their affordability, and many buyers in
Canada over the last two decades have started to focus less on the mortgage amount and more on the monthly payment.
As the saying goes, “You’re buying a monthly payment.”
Many buyers of a $1,000,000 home, who have a 20% down payment, don’t really look at the fact that they have an $800,000 mortgage, but rather choose to look at the $4,203.83 per month mortgage payment (assuming a 3.99% rate over 25 years).
The perspective has changed. In previous generations, it was all about that “colossal bank loan” that the buyer was obtaining. An $800,000 mortgage? Really? That’s a lot of money!
But in today’s market, what matters most is the monthly payment.
Can the buyer of this home afford a payment of $4,203.83 per month payment? If the answer is, “Yes, no problem, it’s easy to us,” then the mortgage amount is secondary.
For buyers on smaller margins, that monthly payment is the only thing between them and the house they want, and if they can’t afford the payment, then they need to change interest rate, amortization period, or down payment.
Speaking of affordability, here are some more posts you might find interesting:
- Is It Smart to Buy a Home When Interest Rates Are High?
- Is it Possible to Buy Your First Home in Toronto Today?
- Can You Still Find Cheap Real Estate in Toronto?
3) Remember why you’re buying a home.
Excuse the sales pitch, but here’s an example that I give to buyers to demonstrate how there’s more to a real estate purchase than just the price.
Let’s say that you and your partner are 3-months pregnant and you’re shopping for a home.
Now, let’s say that you could purchase a home today for $1,000,000 and close in three months, thereby getting into the home in time to feather the nest, prepare for the baby, and be able to relax for the latter third of the pregnancy.
If I told you with a 70% certainty that you could purchase this same home in six months for $980,000, would you hold off on the purchase?
This is a real “thinker” and there’s a reason why I give my clients this scenario.
On the one hand, a $20,000 difference in the purchase price is massive!
On the other hand, I said there was a 70% chance, so is that a chance worth taking?
Nobody has a crystal ball and nothing is for certain, so I’ve never quite understood buyers who want to buy today and some who really need to buy, but who choose to wait because they think a better deal or lower interest rates are just around the corner.
I can tell you from personal experience and from that of dozens of clients that there are many examples of intangible value when buying a home that combine to render the purchase price second-fiddle.
In the example above, you simply can’t put a price on the peace of mind that couple would achieve by moving three months before the baby is due, rather than pounding the pavement searching for a home with a newborn. And in most of those cases, the buyers end up putting their searches on hold for months or years after that birth, so the idea of a market discount is rendered moot.
Consider the buyer who paid $670,000 for a condo after a soul-searching, mind-numbing decision process to increase his offer from $650,000. That was a lot at the time, and it increased the monthly mortgage payments as well. But ask the buyer eight years later, after living the best years of his life in that condo, creating memories, meeting the woman who would become his wife – and selling the condo for $1,100,000, if the higher purchase price made a difference.
Not a chance.
Now, ask that same buyer if he ever considered whether interest rates would decline in a month, or three, or six, and whether that was directing the search, and he’ll say that this was never a factor.
Interest rates are important in the context of a housing search, but they should never push a buyer off course on the road toward home ownership.
Looking for more in-depth buying advice? Download our Buyer’s Guide right here.
4) Remember how hard it is to time the market.
Do you gamble?
If the very best odds in any casino game is 50%, then why would anybody think they can “win” with any regularity or predictability?
You’ve heard the saying, “The house always wins” when it comes to casinos, but the same is true with the real estate market. It always prevails.
On a long enough time horizon, a patient buyer is too patient, and is left behind.
The Toronto real estate market has been increasing for two decades, and while there have been some peaks and valleys, highs and lows, and some periods of market weakness, the average home price curve is more like a 45-degree line from left to right.
As we noted at the onset, when interest rates decline, prices increase. So the buyer “waiting for lower interest rates” is going to have increased buying power, but if home prices are higher then wouldn’t it just be a wash?
Consider this: you’re in love with a house that costs $1,000,000 in a market where interest rates are currently 4.99%. With a 20% down payment, that house would cost you $4,648.29 per month.
But you don’t like the idea of paying that whopping 4.99% interest rate, so you decide to wait until interest rates are lower.
Let’s say that you time the market accordingly and predict right: interest rates have declined and now you can get a 2.99% rate. That would make your monthly payment only $3,781.86 per month!
But here’s the problem: that house is now worth $1,200,000 because it’s been two years, homes have appreciated, buyers have more buying power and there are more of them!
So that $1,200,000 house, even at 2.99%, still carries for $4,538.23 pear month.
Sure, you’re paying $110 per month less.
But you’re paying $200,000 more for the house and your down payment is $24,000 higher.
The example is rudimentary and subjective but it proves a point: gambling within a market that’s increased for two decades isn’t as easy as many buyers make it out to be.
Interest rates are important, but they’re not a reason to wait years to buy a home…
So many people ask us about timing the market. If you have more questions about the timing around buying a home, read these posts next:
- Is Seasonality Over in Real Estate?
- When is the Best Time to Buy a Home in Toronto?
- Why Waiting for the Housing Market to Improve Doesn’t Make Sense
5) Remember that there’s more to a mortgage than simply the interest rate.
There’s also more than just your bank who can help you obtain the loan. In fact, we have always recommended working with a mortgage broker over a bank for a multitude of reasons.
A mortgage broker will work with all the lenders whereas a bank is merely one. A mortgage broker can offer insight and analysis of different products from different lenders, because another thing you need to remember – not all mortgages are the same, whereas the in-house mortgage specialist at your bank is only able to offer what that bank can provide.
Aside from just the interest rate, you need to consider your amortization period – whether it’s the conventional 25-years or a longer 30-year amortization that is now being permitted by the CMHC for all borrowers. How this changes the monthly payment is very important, since the 30-year amortization lowers the amount due to the bank, but how those payments are divided into principal repayment and interest payments is just as crucial.
There are “features” of a mortgage as well, such as your pre-payment privileges, portability, discharge fees, and of course the ability to pay bi-weekly rather than monthly, which costs you the same at the end of the year, but helps to pay down more principal.
As for the age-old debate, “variable-rate versus fixed-rate,” this is ever-changing and proves, yet again, that the interest rate can never be viewed on its own without considering a host of other variables and criteria.
Interest rates play a major role in home-buying activity, but they’re not the be-all and end-all. In fact, it’s more about the implications of the rates themselves, and the host of considerations that stem from the rates, and the impact the rates have on the market, than the percentage that the Bank of Canada has set, or that your bank has offered on your mortgage.
A savvy buyer will consider all of this when making a purchasing decision, but no buyer is expected to do this on their own. For an introduction to our in-house mortgage broker, and to discuss your purchasing journey and the current interest rate environment, please feel free to reach out!
Do you have questions about the market? Reach out by calling 416.642.2660 or emailing admin@torontorealtygroup.com.
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