I am. My wife tells me all the time, but I think she’s referring to something else…
Let’s talk about price sensitivity, specifically as it pertains to interest rates, and how a changing mortgage market affects some real estate buyers, and not others…
Yeah, seriously. My wife tells me constantly, “You’re too sensitive!” It’s like I’m the woman, and she’s the man. But how am I supposed to react when she says, “Can you please move your gigantic bobblehead out of the way – I can’t see the TV!”
I was chatting with my mortgage broker the other day about interest rates; where they’ve been, where they’re headed, etc.
Talk to guys in their late 40’s and early 50’s, and they’ll laugh when we complain about interest rates.
No, I’m not old enough to remember interest rates when they were at 22%. But that also means I’m not old enough to remember the miserable synthesizer-enduced music produced during the same time period, as well as the hair, the jeans, and Little House On The Prarie…
Sometimes, you just have to put things into context. Complaining about your 3.39%, five-year fixed rate is a really selfish act, given that rates were as high as 22% in the early 1980’s, or as high as 5.99% as recent as 2007.
And then sometimes, you just don’t care what rates were thirty years ago, because it has absolutely, positively, nothing to do with the discussion of affordability today.
But just for fun, I’d like to demonstrate what life would be like in today’s real estate market, if rates were 22%.
First, we have the young, entry-level condo buyer, who buys a place in King West for $350,000, with a 10% down payment, on a 25-year amortization. His monthly mortgage payments are $5,577.93, of which approximately $32 is principal, and $5,524 is interest during the first year.
Second, we have the established, 30-something couple, who buys a house in Bloor West Village for $800,000, with a 20% down payment, on a 30-year amorization. Their monthly mortgage payment is $11,250.58, of which approximately $24 is principal, and $11,227 is interest during the first year.
If that 30-something couple paid 22% interest for the entire course of their 30-year loan, they would pay $4,210,207 for that $800,000 house.
But that’s ridiculous, right?
Stories like that are only read about in textbooks, and talked about in the parking lot of a golf course as some old-timer pats you on the shoulder and calls you “Junior”?
Well, 22% interest rates did happen, although clearly not for a 30-year period. That’s just crazy!
But even crazier, are the borrowers today who spend their time dwelling on the fact that their mortgage broker got them a rate that was 3-basis points higher than what their friend got from his bank. THREE BASIS POINTS, people!
Or crazier than that, are the would-be property-buyers who are fretting over a 20-basis-point jump in interest rates.
That’s crazy, right?
Or is it?
I guess the answer is different for everybody, and it all depends on your price sensitivity.
Here’s where the market bulls and the market bears show their true colors. As the saying goes, “You can make numbers say anything you want,” so I think I’ll do exactly that right now.
I’m going to use the same numbers, and argue both sides of the coin.
Purchase Price: $350,000
Down Payment: $35,000
Interest Rates: 2.89% versus 3.39%, 25-year amortization
Market BULLS and real estate pushers would say:
“Are you really going to change your life’s course for a paltry 50-basis points?
The difference in your mortgage payment equates to $18.81 per week. Really? A twenty-bone? That’s one cab ride from your condo to King West!”
Market BEARS and real estate averse people would say:
“A jump from a rate of 2.89% to a rate of 3.39% represents a 17% increase in the amount you’re being charged to borrow.
You’re paying an additional $81.47 per month in your mortgage, which represents a bump of 5.4% in your largest expenditure. That’s almost $1,000 per year, which at your age, and with your income, could take you months to save.
If you own this condo for five years, you’ll pay almost $8,000 more in interest due to that higher rate.”
As I said, you can argue this either way.
It all depends on you price sensitivity, and each individual has to decide for his or herself just how flexible their budget is.
A Gross Debt Service ratio (or GDS) is the percentage of the borrower’s income that is needed to pay all required monthly housing costs (mortgage payments, property taxes, heat and 50% of condo fees). This number typically hovers around 32%, or 39% for insured mortgages (ie. those with less than 20% down, insured by CMHC).
So let’s look at this example again, and determine how much rates have to increase to really have an affect.
Assume that Johnny makes $59,000 per year.
He’s looking at this condo – $350,000, with 10% down, on a 25-year amortization, that has $365/month condo fees, and $1,828.50 property taxes.
With a 5-year, fixed mortgage rate of 2.89%, his monthly mortgage payment is $1494.00. Adding in 50% of the $365/month for maintenance fees, and the $152.38/month for taxes, his all-in cost for GDS purposes is $1828.28.
That’s a GDS of 37.2%, and thus he falls within the acceptable range for mortgage purposes.
With a 5-year, fixed mortgage rate of 3.39%, his monthly mortgage payment is $1,575.47. Now, all-in cost for GDS purposes is $1910.35.
That’s a GDS of 38.8%, and thus he still falls within the acceptable range for mortgage purposes. Yes, that’s cutting it close under the 39% ceiling, but I made these numbers work that way for a reason.
The point is that a “whopping” 50-basis-point increase still keeps a potential buyer’s mortgage pre-approval intact, and we’re working with entry-level buyers here. The higher category buyers would likely have less price sensitivity.
Last week, I talked about the “entitlement generation,” and how a lot of (not all, as some of my readers were quick to point out) today’s youth aren’t quite in touch with the true value of a dollar, or how far a dollar goes, or what life is like when your parents aren’t subsidizing it.
By the same token, you could say that today’s mortgage borrowers are also severely entitled, since so much of the current buyer pool feels hard-done-by that they missed out on 2.89%, 5-year, fixed-rate mortgages, and now have to endure the hardship of 3.39%.
Put this in context!
How low is 3.39%? It’s insanely low!
And you know what? If rates go up another 50 BPS in the next year, as many people suspect, then deal with your awful, miserable, unfair 3.89% rate. It’s still insanely low.
When rates get over 5.0%, if that happens, then we can have this conversation again.
Wait, let’s not wait. Let’s have it NOW!
Using the same example above, let’s see what the monthly carrying cost of Johnny’s condo is at 5.0%.
The mortgage payment increases to $1,853.06, so the all-in cost for GDS purposes is now $2,187.94.
That means the GDS ratio is now 44.5%, and Johnny will no longer qualify for his mortgage.
But from 2.89%, where rates were a few months back, to 5.0%, in our ficticious example, is almost DOUBLING rates. We’re a long way from that.
Market bears – feel free to tear this blog post apart. I probably won’t disagree that low interest rates have been propping up the market, and that house prices WILL decrease in the future if/when rates increase.
But as for the idea of price sensitivity, I have a hard time believing that most buyers would feel affected by an increase in rates from 2.89% to 3.39%.
Tell me if you think I’m wrong, but just be gentle.
After all, I’m a bit sensitive…