Unless you have been living under a rock, I’m sure you’ve heard how “crazy” the real estate market has been over the last few years. We have been seeing homes selling for 100’s of thousands over asking, with no conditions and that was the norm. Home inspection? Forget it. Financing condition? Good luck. Condition to sell your current home? Now I’m laughing, but lately you might be starting to hear a different tune.
Over the past few months we have started to see a shift in the market to a more balanced market. There are still homes selling over list, but we are starting to see a slow in the demand and buyer’s are starting to be a little more cautious with how they are spending their money. So, what changed? There are many factors that drove the highly competitive “sellers’ market” over the past few years, but in my opinion interest rates were the true driving force. The bank of Canada has been raising rates slowly over the past few months and we are now really starting to see its impact. So, let’s take a closer look into what interest rates are and how they affect the real estate market.
What is an interest rate?
An interest rate is the amount of money your lender (bank, credit union etc) will charge you for borrowing money from them. This is usually calculated annually as a percentage of the loan outstanding. For example: If you bought a house for $500,000.00 and put down 20%, you would need to borrow $400,000.00 from the bank. On this $400,000.00 they are offering you an interest rate of 3.6%; that means that you would be paying $14,400.00 (400,000 x 0.036) in interest for that first year to borrow 400K. The interest paid goes down slightly each year as you pay down your principal amount, but your payments will stay the same for the entire term that you agreed to. This results in a SLIGHT increase in your monthly payment going towards the principal amount of your mortgage and less interest paid each year. (once again emphasizing SLIGHT).
Why do interest rates affect the market?
Simply put, when interest rates are low, buyers have more buying power. What that means is that with a lower rate, buyers can afford a higher monthly payment as they are paying less interest on the amount they are borrowing.
Now for some of the first time home buyers out there, you might be wondering why these rates would have such an impact on the market, but just a 1% increase could mean 100’s of dollars more for you per month depending on how much you are borrowing.
Let’s use the same example as before:
Purchase Price: 500k with a 20% down payment
Amount Borrowing: 400K
Interest rate of 1.6% - $6,400.00/year or $533/month in interest for the first year or $29,272.00 for the 5 year term (this is the rate a lot of banks were offering during the pandemic for a 5 year fixed term)
Interest rate of 3.6% - $14,400.00/year or $1200/month in interest for the first year or $66,844.00 for the 5 year term (this was the average rate prior to the pandemic for a 5 year fixed term)
Interest rate of 5.24% - $20,960/year or $1746/month in interest for the first year or $98.233.00 for the 5 year term (this is the current rate most banks are offering for a 5 year fixed term)
**(remember this is only the interest, your monthly payment would also have the principal amount on it and that amount depends on your amortization period which is a topic for another day!)
As you can see, that is a difference of almost $69,000.00 over a 5 year term in interest paid on a loan of 400K, which has a huge impact on the affordability of a lot of buyers! This might be a shock to some of you and I will use this as a reminder to those of you who haven’t touched base with their lender in the past few months, PLEASE check in with your mortgage broker, your affordability may have changed!
To sum it up, low interest rates give buyer’s more flexibility and a larger range in what they can afford which is very appealing to buyers as it is costing them less money to borrow money.
When this happens, there is usually a huge influx in demand for homes resulting in homes selling for a lot more money. When interest rates are high, the opposite happens, and that same monthly payment gets you a home in a much lower price range. When this happens, house prices tend to decrease to reflect the buying power of the buyers in that current market.
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