With debt levels at an all-time high and the Canadian economy charging ahead, the days of historically low interest rates appear to be ending. Dalia Barsoum of Streetwise Mortgages prepares investors for the ensuing financial turmoil
In late 2016, rising home prices and towering consumer debt levels spurred the Canadian government to action in the form of a stress test for insured mortgages. That measure can now be seen as just one in a growing series of external steps taken to mitigate demand, which have included new taxes, rent control measures and, thanks to the surprising strength of the Canadian economy, higher interest rates.
The days of rock-bottom borrowing costs are nearing their inevitable end, and more government-mandated financing challenges appear to be on the way. Let’s take a look at how these new interest rates will impact us investors, what we can do to benefit from them and what other issues might be waiting for us in 2018.
Earlier this year, the Bank of Canada signalled its plans to raise its prime rate, which has a direct impact on variable-rate mortgages. The first increase of 25 basis points took place in July, followed by a second increase of equal value in September. The sudden adjustment reflects the measures the bank has taken to influence stronger-than- expected economic growth. Based on Canada’s stability and economic outlook – both unpredictable, but generally assumed to continue – we can safely assume there will be further increases over the next five years. The timing of such increases, however, remains uncertain and is largely dependent on how GDP and inflation will grow.
As an investor, the first question that should come to mind is: “Should I lock in or stick with a variable-rate mortgage?” Research conducted by Dr. Moshe Milevsky of the Schulich School of Business in 2007 shows that Canadians would have been better off borrowing at a variable rate compared to a five-year fixed rate 89% of the time. However, the current gap between fixed and variable rates is very small, which makes fixed-rate mortgages attractive at the moment. Consider the following factors when attempting to manage interest-rate exposure:
If you have variable-rate mortgages and have recently positioned equity in one or more properties, consider locking in the rate on some of these properties, especially the ones you plan on keeping long-term and where the cash flow may be sensitive to fluctuations. Leave some out, especially the ones that have healthier cash flow and can withstand an increase.
If you have variable-rate mortgages and have large amounts of trapped equity in your properties, consider positioning that equity sooner rather than later – even if you don’t require it immediately – through a secured line of credit. In particular, consider mortgage products that would allow you to split your mortgage into variable- and fixed-rate components simultaneously. Positioning equity now reduces your risk of needing to access that equity later and therefore getting caught in the interest-rate cycles at the time of qualifying. It also gives you the opportunity to lock in a portion of your mortgage on that property and hedge against an increase.
If you have a large revolving line of credit that you have used for down payment funds, consider converting portions of that line of credit into a fixed-rate mortgage.
Finally, stress-test the cash flow at the portfolio level with a 5% interest rate for properties that will remain on a variable rate and for interest payments on any secured lines of credit. If you are running a negative cash flow, you should consider locking in a larger portion of the portfolio.
More changes on the way
The Office of the Superintendent of Financial Institutions, which regulates Canada’s banks, recently announced its plans to implement a stress test rule for uninsured mortgages that would require borrowers who are refinancing or purchasing with 20% down or more to qualify for a mortgage at 200 basis points higher than the rate they are actually being approved for. This policy is slated to be finalized by the end of the year and will have a direct impact on real estate investors who are purchasing or refinancing residential properties of one to four units once it is put into effect.
The extent of the impact on your ability to either purchase your next set of properties or take out equity will depend on your individual financial circumstances. Consult with your financial planner or mortgage broker now to ensure that any plans you have to increase the size of your portfolio can be carried out with as little drama as possible.
Dalia Barsoum is an award-winning mortgage broker, real estate investor and finance advisor with more than 20 years of experience. She is the best-selling author of Canadian Real Estate Investor Financing: 7 Secrets to Getting All the Money You Want. To learn more, contact her at firstname.lastname@example.org or visit streetwisemortgages.com.
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