Interest rate hike spells trouble

BY: JAY BRIJPAUL 

The Bank of Canada increased its interest rate last month and we are expecting to see further rate hikes coming soon. Since 2017, the interest rate has gone up five times and the benchmark, at 1.75%, is at its highest level in ten years. The Bank of Canada plans to increase the rates soon between 2.5% and 3%. Interest rate hikes are necessary to cool an overheated economy and will reduce inflation in the long run.

Rising household debts are the main concern. Interest rate hikes should prevent consumers from overspending. With higher interest rates, a wage freeze and the stress test, it is likely that the housing market will decline. It is estimated that one in three Canadians will fail the stress test at the current interest rate. Builders are now shifting gears towards smaller, more affordable homes.

With high debt load and interest rate hikes, monthly payments will continue to rise. Combine that with the property tax increase, insurance, and utilities, we must be diligent in our spending habits. The trend is to downsize to more affordable homes, fewer debts, lower taxes, and more vacations. Speculators who are buying multiple properties hoping to make a quick profit should be careful because a shift in interest rates can trigger a correction. Investors should focus on paying down their debts and holding onto cash so that they can feast when there is famine in the industry.

Interest rate hikes are certain because our economy is surging, and unemployment is around 4%. It is a good time to lock in mortgage rates. A fixed rate is good for budgeting, but variable rates offer the best discount. Consumers should only spend about 35% of their income on their mortgage, property taxes and utilities and an extra 10% on other debts. The remainder of the income should cover other living expenses and savings. The best way to save is to scoop 10% of your income upfront and then budget on the 90%.

According to Environics Analytics, the average cost of the hikes so far to average households is $2,500. The debt service ratio which the bank uses for mortgage qualification increased in 2017 to 6.4%. It is expected to climb to 7.2% by the end of 2018. Young middle-class families will be affected because of their debt load. Many of these families, in addition to their mortgages, have other debts such as car and student loans.

Many families are living from one pay cheque to the next and when interest rates climb, it becomes even more stressful. Debt consolidation is one of the best ways to reduce monthly payments. It is better to increase the mortgage and pay off the other debts for someone with multiple loans to pay such as a car loan, credit cards debts and mortgage payments. Since mortgage payments are calculated over 25 years, the monthly payment will be far less than paying the debts separately. For others who have lived in their home for a long time and are having difficulty paying their mortgage, it is better to increase the number of years of payment back to 25 years or in some cases to 30 years to reduce the monthly payment. While this is not the best option to build wealth, it will certainly prevent drowning in debts.

Homes with income potential are a good option. An average basement apartment fetches $1,400 per month. The extra income can be used to pay down debts and build wealth. Owners living in townhomes and paying high maintenance fees should consider moving to freehold properties with a basement apartment. It is cheaper because of the savings from the maintenance fees and the rental income.

With interest rates increasing, home prices will fall. We are expecting a gradual drop but in the long term, prices will continue to climb because of the demand for homes. Real estate is a true shelter for you to live in and also a shelter for inflation.  Here is a quote from Robert Kiyosaki, an authority in the investment world: “Real estate investing, even on a very small scale, remains a tried and true means of building an individual’s cash flow and wealth.”