What You Need to Know About Low Mortgage Rates

Today’s teeny-tiny interest rates look pretty good if you hope to borrow a lot of money. For the majority of people, the biggest loan you’ll ever take is one to buy a home. With an average home price of $470,297 across Canada (and prices higher in Toronto and Vancouver), chances are you’ll need to borrow an enormous sum of money for a mortgage.

As you compare low mortgage rates and decide how much house to buy, here are a few things to keep in mind:

This won’t last forever

It’s easy to forget that only 10 years ago banks were paying 4% on savings accounts. This was paid for by banks charging interest rates over 5% for mortgages. If you go back 20 years, you can see that Canadians were struggling with 8.5% mortgage rates, and 30 years ago we would have been paying over 12%.

Obviously no one wants to return to the 1980s and the corresponding high mortgage rates. Hoping that mortgage rates will stay this low forever though is unwise. Low mortgage rates are not only unsustainable, but they could be a sign of greater problems in the economy – and no one wants problems with the economy.

Cheaper mortgages

Mortgage rates are the cost of borrowing money, and the lower the rate is, the lower a mortgage payment will be. A $100,000 loan at 3% interest costs $475 per month for 25 years. The same loan at 6% interest costs $645 per month for 25 years.

Low mortgage rates allow people who never dreamed of owning a home to afford one. In fact, mortgage rates can sometimes be so low that it’s cheaper to buy a house, from a monthly cash flow perspective, than it is to rent.

Bigger houses

Low mortgage rates also enable people to buy more expensive houses than they would otherwise be able to. For example, a $100,000 loan at 6% would cost the borrower $645 per month. With a 3% interest rate, the same shopper could afford to buy a home that costs $140,000.

Unfortunately, since more people can afford to buy more expensive homes, low mortgage rates can create bidding wars with too many buyers chasing too few homes. These bidding wars cause the prices of houses to increase and can lead to a bubble. And don’t forget that the new down payment rules can mean that this home price inflation can have an adverse effect as prices soar.

Low mortgage rates can also be disastrous for certain homeowners. In Canada, mortgage rates are adjusted periodically throughout the life of the mortgage; the frequency depends on how long the term is. While interest rates are 3% today, they could rise to 6% in five years when the mortgage term is up. In that case, the homeowner would be forced to pay the higher mortgage payment. Buy a house that’s too expensive, and the higher payments might be unaffordable. This is what happened in America in 2007 and was a leading cause of the 2008-2009 financial crisis.

Low mortgage rates allow people to afford homes at lower prices than they would have paid at any other time in recent history. These rates also mean that we can afford to buy more expensive homes than before.

However, it’s important to approach these rates with caution, and make a reasoned choice as you shop around for your own home.