Will our housing market eventually calm down after a sharp increase in interest rates? We’ll soon learn.
Years of low rates fueled demand, making house ownership accessible to more Canadians and paving the way for investors and move-up buyers. However, with inflation at a three-decade high, the Bank of Canada is now changing course and indicating it will considerably raise interest rates in the coming year. This, in our opinion, will dramatically change the market.
High Rates
In March, the Bank of Canada started to adjust its monetary policy, turning higher rates into a concrete reality rather than an unsure promise for the future. Additionally, The Bank’s announcement on April 13 of a 50-basis point increase to 1.0 percent indicated a desire to move swiftly toward raising its policy rate to a neutral level by year’s end. In less than six months, we anticipate this to increase by another 100 basis points to 2.0 percent, which is slightly higher than pre-pandemic levels (1.75 percent). Since the tightening cycle in 2005–2006, Canadians haven’t experienced an increase this significant in such a short amount of time.
The Housing Market: Why Interest Rates Matter
For a number of reasons, interest rates are significant to the housing market. They affect the price of real estate and how much we will have to spend to borrow money to purchase a property. While high interest rates typically have the opposite effect, low interest rates tend to promote property demand and raise prices.
Mortgage Loans
Fixed rate and adjustable-rate mortgage loans are the two main types of mortgage loans, and each has several derivatives and hybrid combinations. Making financially responsible mortgage decisions can be aided by having a basic awareness of interest rates and the economic factors that will affect their future direction. Such choices include deciding whether to refinance out of an ARM or to choose between a fixed-rate mortgage and an adjustable-rate mortgage (ARM).
What Factors Determine Interest Rates?
The amount that a bank charges a lender for the use of assets on top of the principal is known as the interest rate. The status of the economy is one of several variables that affect the interest rate that banks and financial institutions charge. The interest rate is determined by the central bank of a nation, and each bank uses that rate to establish the range of annual percentage rates (APRs) that they provide.
When inflation is strong, central banks often increase interest rates since doing so increases the cost of debt, which deters borrowing and decreases demand.
The cost of mortgages is impacted by a variety of factors. The general cost of borrowing in the economy, which is dependent on the status of the economy and monetary policy of the government, will be taken into account by lenders first. The cost of obtaining a loan to purchase a home will then depend on personal criteria, like your credit history, income, and the type and size of loan you are seeking.
The mortgage originator, the aggregator, and the investor are the three main entities that make up the mortgage industry.
Mortgage Originator
Lenders are those who originate mortgages. Banks and credit unions are two examples of different types of lenders. Mortgage brokers compete with one another based on the interest rates, costs, and services they provide to consumers as they introduce, promote, and sell loans to them. Their profit margins are based on the interest rates and fees they charge.
The majority of mortgage originators do not retain the loan asset; the mortgage is frequently sold into the secondary mortgage market instead. Their profit margins and the price at which they can resell the mortgage on the secondary mortgage market dictate the interest rates that they charge consumers.
Aggregator
Newly created mortgages are purchased by the aggregator from other banks. The majority of them are also mortgage originators, making them a part of the secondary mortgage market. Mortgage-backed securities (MBS) are created by aggregators who group a number of comparable mortgages together—a procedure known as securitization.
Investor
Pension funds, mutual funds, banks, hedge funds, foreign governments, insurance companies, and government-sponsored enterprises are just a few of the many investors in Mortgage-backed securities.
Investors regularly do comparative value assessments between MBS and other fixed-income investments, such as corporate bonds, in an effort to maximize returns. Investor demand for Mortgage-backed securities dictates the price that investors will pay, as it does for all financial products.
Mortgage rates that are made available to customers are mostly determined by MBS investors. As previously stated, an investor will purchase Mortgage-backed securities as the final product of the mortgage production line.
The market clearing prices investors will pay for Mortgage-backed securities are decided by the free market. The interest rates you’ll be given when you purchase a home are determined by these pricing as they make their way back through the mortgage sector.
Fixed-Rate Mortgages & Adjustable-Rate Mortgages
The two most common types of mortgages are fixed Rate and adjustable rate.
A fixed-rate mortgage’s interest rate is set for the duration of the loan. However, because consumers move or refinance their mortgages, 30-year fixed-rate mortgages often have a shorter duration.
Depending on the conditions of the mortgage, the interest rate on an adjustable-rate mortgage (ARM) may change every month, every six months, once a year, or less frequently. An index value and a margin make up the interest rate. The interest rate that is fully indexed is this. Typically, it is rounded to the nearest eighth of a percentage point.
Conclusion
The fact that interest rates are still low is good news for homebuyers, and the market currently features some of the least expensive financing a house buyer will be able to take on.
Finding the correct mortgage ultimately depends on getting the right guidance from a seasoned real estate professional who personally owns a large number of properties and has completed a large number of real estate sales for others. Prospective investors can feel more informed, certain, and secure about their financial decisions by working with an expert.
