The Bank of Montreal Wealth Institute has released a new survey that shows nearly one in six Canadians couldn’t afford a $500 increase in their monthly mortgage payments.
The results are startling, said BNN, the financial news television station, when introducing the survey results.
According to the bank, 16% of those surveyed said they would never be able to afford the increase. Another 27% said they would have to make adjustments to their budgets to make ends meet. Yet another 26% said they would be concerned, but they could probably handle it.
No doubt. A $500 a month increase amounts to $6,000 a year, enough to make a dent in most family finance plans.
But when you drill down through the numbers, for a $500 boost, interest rates would have to go up by three percentage points—from 2.75% to 5.75% on a $300,000 mortgage with a 25-year amortization period.
That is not likely to happen. Interest rates are low and there is no indication they will go up any time soon. The Bank of Canada has certainly not given signals that it has any plans to change its low rate policy.
Even if there is a change of heart, rates will go up gradually, not in one fell swoop. You won’t wake up one morning with a lender asking you to cough up or get out.
When rates do go up or down, they tend to move by 25 basis points or 50 basis points at the most. That’s 0.25% to 0.5%—much easier to swallow.
If interest rates do increase at the most likely rate of 25 basis points per occasion, they would have to go up 12 times from 2.75% to reach 5.75%.
Most Canadians have fixed-rate mortgages over 5 years, the most popular mortgage term, so it could be quite a while before they would need to negotiate a renewal. However, with rates as low as they are, (and if this survey spooks you), maybe it is an incentive to think about locking in.
The BMO survey goes on to say that 40% of Canadians have been influenced by the low interest rates to buy too much house. The doomsayers are using this survey to make the point that Canadians are over-extended because of low interest rates and that the findings should be a warning to pay down debt and start tightening their belts.
There is another factor. In his new book, The Wealthy Barber Returns, financial guru David Chilton quotes a 1772 essay by the French philosopher, Denis Diderot. In Regrets on Parting with My Old Dressing Gown: Or, a Warning to Those Who Have More Taste than Money, Diderot writes about getting a beautiful new dressing gown that makes everything in his surroundings look shabby. As a result, he is compelled to replace his tapestries, his artwork, and his furniture.
Chilton applies this concept to the modern adventure of buying a house that is nicer than you can afford. David Chilton is the keynote speaker at the 2015 Canadian Personal Finance Conference where he is sure to elaborate.
I want to end with a story about my friend Nancy. The house she had her eye on meant that her mortgage would be $20 a month more than she budgeted.
We sat down and considered the Latte Factor, a term coined by financial commentator David Bach in his book Finish Rich, which expresses the idea that the trivial things we spend on every day add up over time. His theory is that it is better to take on a bigger mortgage than to splurge on candy, cigarettes, or premium cable TV.
We were optimistic rather than pessimistic about interest rates and the uncertainty of life. Sure enough, Nancy soon got a promotion with a raise. She enjoys her new house and we still go to Starbucks, where she continues to treat me to lattes.
Flickr: Fairview Condo