Most people who read the question, “Is it smart to buy a home when interest rates are high?” will likely have a gut-reaction within a split second of finishing this sentence.
And most people, I do believe, would think that the answer is “no.”
That’s fair. There’s no right or wrong answer to this question, although I’m sure Google’s algorithm and the readers here would prefer if the area wasn’t so grey.
But the truth is: when to buy a house is different for everybody, and the “when” is affected by many factors.
Why does a person buy a home? At its most basic level, it’s to acquire shelter. But is this person renting? Does this person own a small condo? Is this person moving to the city for the first time? What is the individuals’ financial situation? Where is this person in their life cycle?
So many questions and yet every single question adds another layer of complexity to the answer. But we haven’t even got to “market conditions” yet, and that is ultimately the deciding factor for most buyers.
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Is the Market Hot? Is it Cold? When is the “Best” Time to Buy?
Ironically, most people prefer to purchase in a hot market. It goes against the grain, but people are inherently afraid of catching a falling knife.
“Catching a falling knife.” Perhaps this needs an explanation.
Let’s say that a particular stock is trading for $100 but we enter into a cold or bear market. The stock drops to $90, then to $80, then to $70, where it seems like a steal. The stock pays a dividend, it’s a blue chip, and there’s a history of this stock fluctuating and it seemingly will return to $100+ once more. But human nature is such that most people won’t pull the trigger as the stock is going down. Instead, most people would wait for the stock to turn back up to $75, then $80, then buy at $85 as it moves back to $100 and beyond.
Why?
Human nature. People seem to be prone to avoiding risk, minimizing downside, and taking the easier path.
But when it comes to purchasing a home when interest rates are high, it goes completely against the grain, and yet it makes so much sense for many buyers.
Consider that there is an inverse relationship between interest rates and price. So when interest rates go up, in theory, prices come down.
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Let’s Look at a Real-World Example
So let’s say that a house was $1,300,000 when interest rates were at 2%. And let’s say that a massive increase interest rates – up to 6%, causes that home to drop in value to $100,000.
With a 20% down payment, the monthly mortgage payment on the $1,300,000 house at 2% would be $3,839.74. And for the $1,000,000 house at 6%, the monthly payment would be $4,758.59.
Yes, you’re paying $918.85 more per month.
But you’re buying the home for $300,000 less!
So let’s say that you pay $918.85 more, per month, every month, for the term of a five-year, fixed-rate mortgage.
That means you pay $55,131 more in mortgage payments.
But again, you’re getting the house for $300,000 less!
Not every house, in every market, in every city is going to appreciate back to the value where it once was, but on a long enough time horizon they will!
How Does this Apply to Toronto?
In Toronto, we saw a 20% drop in home values in the spring of 2017 and that value was gained back by the spring of 2020.
So if we believe in the long-term prospects of the real estate market that we’re in, there should be no problem waiting for a return to peak-value, even as interest rates are higher.
Consider the situation above for a moment. After five years at 6%, there’s a good chance that we could find ourselves in a low-interest rate cycle. If that buyer comes out after five years, having paid $55,131 more for the home, and rates are low, then not only will the value of the home be much higher, but the interest rate renewal will be lower as well.
In investing, in any market, it often pays to run toward the fire when everybody else is running away.
Looking for buying advice for today’s market? Get in touch directly, call 416.642.2660 or email us at admin@torontorealtygroup.com today.
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