Interest rate hike puts investors at risk

The heat may be getting to some as a scorching real estate market has analysts suggesting a slight rise in interest rates could effectively cool the market but it could spell trouble for some investors.'

“The big risk going forward that really hasn’t been significant until last year is around mortgage renewal risk or financing renewal risk,” Dr. John Andrew, real estate professor at Queen’s University, told CREW.

“It’s great to decide to buy a condominium and rent it out and that’s part of your retirement plan when you buy that condo with 4.2 per cent money but what happens when that mortgage renews in five years and maybe it’s seven per cent? Can you afford to keep that unit? Can you collect enough rent to service the loan? That’s the big risk going forward for investors.”

The comments come following an address from U.S. Federal Reserve Chair Janet Yellen last week, who warned Canadian homeowners and investors to be prepared in the result of an interest rate hike later this year. Many analysts believe that the economy will require a rate hike by the fall if not the end of the year, which could spell trouble for many investors that ostensibly aren’t prepared for the increase.

"The importance of the timing of the first decision to raise rates is something that should not be overblown, whether it is September or December or March," said Yellen, during her speech as quoted by the CBC. "What matters is the entire path of rates."

To stay ahead of the game, she offered investors as simple formula to deal with rate cuts: whatever the size of the principal amount you owe, multiply it by one per cent. And for every year, add that amount to your yearly payment.

This will be important for investors to consider as people continue to have misconceptions the impact of interest rate hikes.

“They think the bank is stress-testing their ability to make those payments, but most of the financial institutions are not doing a very responsible job of that,” Dr. Andrew said.

“They can probably hold on until around five per cent or six per cent, but then there’s no way they can put their rents up enough to cover the loan, if that loan is seven per cent or eight per cent. That’s a big risk going forward.”

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