Buying is only half the puzzle, the mortgage comes next

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In the midst of a pandemic, with real estate prices across Canada over 30 per cent higher than in 2020, Cara Vandermey and Yash Mamtora bought a house.

“Interest rates are at historic lows of 1.5 per cent, so this is absolutely the best time to get into the market,” says Mr. Mamtora, 30, an automotive technician for Volkswagen. “It’s scary, because you don’t know what will happen next, but if not now, when? If prices go up next year, we’d be left looking at one-bedroom condos.”

Despite Bank of Canada concerns over high levels of residential mortgage borrowing with people overstretching to buy and threats of rising interest rates in late 2022, the recently married couple feel they made a smart decision. It wasn’t easy.

They describe their 10-month house-hunting journey as challenging – from the bank’s complicated mortgage pre-approval processes, including the new tougher stress test proving they could make payments at 5.25 per cent interest, to toxic bidding competitions. They were priced out of Cambridge, their first choice near family in Kitchener-Waterloo, where one house they bid on received 18 offers and sold for $220,000 over list. But giving up was never an option.

“We didn’t want a house and not be able to buy a couch,” says Ms. Vandermey, 33, a team lead for Shopify and freelance illustrator who works from home. “So, we started looking outside big cities within reasonable driving distance of friends and family where we could still have a nice quality of life.”

The pair stuck to their pre-approval budget, despite bidding $45,000 over the asking price of $480,000 to get a “beautiful, three-bedroom, two-bath split level with a backyard” in picturesque Walkerton, Ont. They feel they got good value for the money.

Now, like 88 per cent of Canadian homeowners aged 25 to 44, the couple needs to negotiate a mortgage. They take possession in July and are currently deciding between a fixed or variable interest rate mortgage – both historically low.

Variable fluctuates based on the Bank of Canada rates, so they could pay more if rates rise, which is a gamble. Like most Canadians, Mr. Mamtora prefers the safety of fixed, which typically locks in payments for a set term of two to five years, but the bank’s offer of 1.55 per cent for variable is tempting. First-time buyers also frequently break their mortgage after three years to get a better deal, so penalties are a consideration as they’re typically higher for a fixed-rate mortgage.

Mike French, head of real estate secured lending for TD Bank Group, advised by e-mail that it’s critical to do your research and understand your options before making a commitment.

“Property ownership is important for many Canadians and we want to help customers get into the market in a way that is consistent with what they can afford and their overall financial goals,” he says. “At the same time, we’re aligned with the government’s goal of ensuring prudent lending and a sound Canadian housing market.”

Some experts have raised concerns about how stretched homeowners will pay their mortgages if rates rise. However, those in the mortgage industry suggest this will be manageable.

While it’s tempting to decide about a mortgage solely on rate, Mr. French suggests looking for flexibility to, for example, make lump-sum payments when you have the opportunity, pre-pay little extra each month or pause a mortgage payment if necessary.

Buyers need to determine if they are comfortable with choosing a fixed or variable rate, knowing that interest rates can change, he says.

“With TD’s variable rate mortgages, if interest rates rise, most customers don’t immediately see a change in their total payment amount,” he explains. “However, more goes towards paying interest, and after you renew your term, your regular payments will likely increase to pay down more of the principal to keep to the same amortization period. So, the impact of rate increases is usually delayed until renewal, similar to a fixed term.”

Alma Pasic, a mortgage broker with Paragon Mortgage in Burnaby, B.C., a Vancouver suburb, says her financially savvy clients mostly choose variable rates. She is seeing lots of local sales right now in a hot sellers’ market: April sales this year were 56.2 per cent above the 10-year April sales average while active listings total were 11.2 per cent below.

“People in Vancouver absolutely believe the market will continue to increase here, although not always at the levels we’ve seen recently,” says Ms. Pasic. “This city favours real estate more than any other investment.“

Besides low interest rates and a shift in family wealth between generations, she attributes it to pent-up demand now that people realize they’re not losing their jobs due to the pandemic; plus, second recreational properties have never been more important. Buying at 20 per cent over list is common, but she says concerns about people overextending themselves are balanced by the protection mechanisms built in by banks and the government.

Ms. Pasic believes the banks aren’t about to bankrupt the citizens of Canada by raising rates quickly.

“I think when people decide to buy, they look at the numbers and go through the process of the banking system, so they know that the banks are not going to overextend them,” says Ms. Pasic. “If you’re in a variable mortgage product, you’re only paying 1.45 per cent. Anyone who passed a stress test, which is the bulk of buyers in Canada, has lots of room to absorb a rise in interest rates right now.”

But if you’re maxed out on debt servicing and higher rates would disrupt your cash flow, she suggests taking a five-year fixed or fixed-rate variable mortgage (where monthly payments are set for the term). Then make prepayments whenever possible to get your mortgage paid down faster if you have that option, she advises.

“If you can make those pre-payments, you’re not so worried about a rise in interest rates because you’ve already increased your payments,” she says. “But if you like having real estate as part of your financial portfolio, there is always a disruptor around the corner. Then all your plans change and you adjust accordingly. It’s just the way life is.”