In the US, mortgage resets are partly responsible for the financial mess that is wreaking havoc throughout the global economy.
In Canada, and Victoria specifically, mortgage resets haven't been a significant issue yet because interest rates haven't fluctuated outside of a two to three percent zone over the past 6 years. We are witnessing an unprecedented period of extremely high prices and extremely low interest rates. While home buyers today are out loading up on overpriced homes at incredibly low interest rates with little to no forethought about what this might do to them financially in five year's time, readers of HHV get to see what it may look like.
If you bought the average home today, using a 5% down, 35 year amortization mortgage, locked in for 5 years at 3.69%, you'd be taking on about $500,000 in debt. This debt will actually cost you more like $1.15 million by the time you're finished paying it off, but that's a whole other issue. What concerns me most, is what this level of debt looks like in five year's time.
Total loan principle: $500,000
Monthly payment: $2120
Principle paid: $38,420
Interest paid: $88,844
Principle outstanding at term end: $461579
Let's make one key assumption here that is backed up by 31 years of Victoria real estate history: the price of your home will not have appreciated at all in this next five year period.
You may have $38K in equity in your home and just enjoyed the lowest interest rates you will ever pay. The economy has recovered, somewhat, and interest rates have increased incrementally over time to something closer to a historical average in the range of six to eight percent. Here's what you could be facing when you go to renew your mortgage:
Monthly payment: $2762
Monthly payment: $3066
Monthly payment: $3380
How many families buying today do you know that could handle a jump in monthly payment of anywhere between $600 and $1200 per month? I don't know any. And if this happens, many of these families will be forced to sell their homes. With $38K in equity, they have few options. REALTOR fees will eat half of that $38K. The market won't be "booming" in an interest rate environment like that, that's for sure, especially if prices have remained high. Wages haven't kept up, neither have rents. It could be a dangerous recipe.
I believe, as do many of the readers here, that we're going to see prices drop another 15% or so over the next several years. If we're right, then the scenario above is really dire as some lenders won't renew mortgages on underwater properties and homeowners may face cash calls.
Let's run some hypothetical numbers based on two more assumptions: prices drop 15% from today's average and interest rates climb 2% over the next two years. Because of the purchase price savings, a buyer is more able to put 10% down and go with a 30 year amortization at 5.69% instead of 35 year amortization. Here's what that looks like:
Total loan principle: $400,000
Monthly payment: $2318
Principle paid: $29,204
Interest paid: $109,876
Principle outstanding at term end: $370,795
Is it moot? From a quick glance, it seems like there really isn't much advantage for waiting. Interest rates will be higher and payments will be higher. The renewal amount is $100K less though (as was the purchase price in this assumption), and that makes a significant difference to a family's ability to continue to afford their own home:
Monthly payment: $2210
Monthly payment: $2460
Monthly payment: $2712
Are we going to see an increase in distressed sales in five year's time because of extremely high prices and low interest rates today? Does it make sense to wait to save potentially save $100K? What numbers are you using in your calculations?