The Canadian government just raised interest rates a full 1 % in one go. How will this affect the housing market and the economy? What critical economic elements benefit from raising interest rates? Are the banks really the bad guys here? Find out this and more today with Senior Financial Advisors Rob McClelland and Mike Connon on ThinkSmart with TMFG.
Transcription
Rob (00:00):
Hello. This is Rob and Mike from The McClelland Financial Group of Assante Capital Management. This is Think Smart with TMFG.
Rob (00:11):
Today, on Think Smart with TMFG, Mike and I are going to be discussing how do high-interest rates play out in Canada’s housing market. Mike, our Canadian government just raised interest rates a full percentage point all at once, probably the first country in the world to increase them as quickly as we have.
Mike (00:37):
Yeah.
Rob (00:38):
What’s the objective there? We’ve touched on this a little bit before in the past. But what are they trying to do? 1% seems to be a big increase.
Mike (00:46):
Well, there are a few things. I’ll go back to a bit of a story. I know this one person that’s moved to Canada from out of the country. Again, they moved in. They’re immigrants, and they have a large mortgage. We were talking one day, and they said the government’s got to do something to control these interest rates on housing prices because they’re going to knock us, so we’re all bankrupt.
Mike (01:13):
Unfortunately, they don’t really know economics. I went and started to give them less. I said, “The government… It’s not their problem to control interest rates on mortgages. It has nothing to do with that. The government has to control inflation.” All this raising interest rates is about inflation. They have to really ignore the housing market because if inflation continued to grow… Let’s say we’re at 7/8%, and let’s say we end up in a situation where inflation’s at 10% a year. Let’s say that goes on for five years. Now, think of every pension plan that’s indexed with inflation. They would all be bankrupt. There’s no way they could ever survive that type of move.
Mike (01:52):
Even if you didn’t have an indexed pension plan, think of any old person living on a fixed pension plan. What would happen to their buying power? They would now have to eat 50% less food than they did this year. The government’s main goal is to control inflation rates because inflation has to stay in control. They got to bring that down to a normalized level of 2 to 3%. Otherwise, everything falls apart.
Mike (02:15):
Again, also with raising and lowering interest rates, they have to make sure they keep up with the US because, if you think about it, interest rates… When you look at different countries, you’re going to invest in a country that’s more secure and has a high-interest payment. If US raised the interest rates and Canada doesn’t, what happens to the Canadian dollar? You can get paid more in the US as a bigger, safer country. You’re not going to invest in Canada so the Canadian dollar will drop.
Rob (02:41):
By raising interest rates in Canada, not only you’re hoping to curb inflation/slow it down, but you’re also protecting your currency.
Mike (02:52):
You need to protect your currency because if your currency falls apart, that’s inflationary. In Canada, how many things do you buy a day that are made in Canada? Everything you buy is from outside of Canada. If our Canadian dollar continues to drop, you won’t be able to afford any goods that are imported into Canada, which is basically everything.
Rob (03:07):
If you take a major purchase that… We don’t make really any cars in Canada. All your cars come from abroad. If the Canadian dollar went down 10% and down into the sixties, those cars are going to immediately go up in price, for us, 10%.
Mike (03:25):
The government with interest rates… The housing market, I guess, is important. But it can’t really be important to the government because if you have a million-dollar mortgage, and it’s more than you could afford, that’s not really the government’s fault. That’s your fault. So You can’t have the government bail you out on things that aren’t their fault. The innocent are being affected by inflation. They didn’t do anything to cause inflation. That just grabbed people. Someone who went out and overpaid for a mortgage and didn’t expect interest rates to go up… That’s their own fault. The government’s job is not to go and protect you and bail you out in that situation.
Rob (04:02):
Let’s drill down and maybe look at a specific situation on just mortgage costs. Let’s say someone had purchased a new home. They had a half million or a $500,000 mortgage. They wanted to take it out over 30 years. Well, at the time, if you’d go back six months ago, interest rates were really low. You could get a variable rate for less than 2%, one and a half percent. That was really attractive. You’re borrowing half a million dollars at one and a half percent.
Rob (04:34):
You could have locked in for a five-year period, but it was closer to three and a half percent: three/three and a half. You were really reluctant to do it. I’m getting one and a half versus three and a half. That’s 2% a year just on half a million dollars. That’s $10,000 of interest difference. That’s huge.
Rob (04:56):
Now that rates have started to creep up, though, everything’s changed. Let’s look now at that fixed rate. Let’s say you decide, “I want to get off this variable rate because it’s gone from one point a half percent to, now, three a half percent. I want to lock in.” Well, the fixed rate is still higher now. It’s 5%. Do you want to lock into five? You’re only at three and a half. But if rates keep going up, you may hit five really soon. What if rates go to six or seven?
Mike (05:28):
I mean, that was normal. When we bought houses, my first mortgage was at, I think, 8%. What was yours at, Rob?
Rob (05:33):
- Right. That’s what it was.
Mike (05:39):
I put some numbers together. A 30-year 500,000 mortgage is 1,846 a month to carry. If you put that up to 5%, it’s $2,668 a month. At 7%, it’s 3,293 a month. You look at that over a year because it’s easier to think of a year. So $22,000, about that for a 2% mortgage. You’re carrying cost for a 5% mortgage is about $32,000 a year. When you move up to 7%, you’re up to $39,000 a year. Think of that: $17,000 more a year in mortgage payments on a $500,000 mortgage.
Rob (06:15):
Let’s say you had 100,000 worth of household income. 30% has gone in taxes. You’re left with 70,000, 70,000 that you can spend on lifestyle, food, shelter. You name it. Of that 70, it’s just gone up $10,000. You got to cut back somewhere else on that 10,000. Certainly, travel’s probably out the window. But you may have to make changes in other things because you can’t risk your house. You’ve got to change what you’re eating. You can’t be going out for dinner. You maybe have to stop buying clothes. Who knows what you have to give up? But you got to make some drastic changes.
Mike (07:00):
One thing I never realized, too, is when I talked to some people who have moved to Canada recently, we’ve had a great banking system. We don’t appreciate how great of a banking system we have. It’s very solid. It’s very secure. They were often massively low-interest rates. If you’re from other parts of the world, they don’t have solid banking systems. People were paying 10 to 20 to 30% interest on mortgage. It blows people away. But if there’s no banking system and you’re doing mortgages on a country that’s unstable, people are paying these giant interest rates along the way. When you come over to Canada and you saw 2% mortgages, why wouldn’t you borrow that? 2% almost free. It’s hard to get closer to free money than 2%. Some people might have overextended themselves with these low-interest rates.
Rob (07:44):
It’s not all bad news. With higher interest rates, definitely, a mortgage would be more expensive. But what we’re starting to see already is that housing prices have stalled and are starting to drop. They’ve dropped literally over the last 12 months. Price drops have happened across the country.
Mike (08:04):
Which is good for young people. Our biggest problem was young people couldn’t afford houses. One thing you have to remember is the carrying cost of a house and how much the interest is, and how much cost you want is a temporary thing. That adjusts all the time. Whatever you pay for a house is a permanent commitment.
Mike (08:22):
You’re better off paying less for a house with higher carrying charges because it would fix itself out. Too many people were worried about how much the carrying charges were rather than what they paid for the house. A house that used to be $700,000, they were paying one and a half million because it was very cheap to carry. But that carrying cost has changed now. Now, they’re stuck with the debt they have. It’s going to last for the rest of their life. That debt doesn’t go away. It’s important to bring the housing prices down to more of a reasonable level where people can afford it. It’s not a terrible thing. There’s a lot of people that are going to lose houses and have some bad experiences in this. We saw this back in the ’90s too. Unfortunately, there’s always collateral damage to these changes that have happened. But they do have to happen too.
Rob (09:09):
It is a tricky time to be buying your first house or doing an upgrade on a house, moving upmarket, whatever it may be. Maybe your mortgage has come for renewal. How do you do this? I guess the good news is the housing prices. If they’ve dropped a little bit, the house becomes a little more affordable. Maybe the mortgage is going to be a little higher. But that may only be for the next three years until we get this inflation thing under control.
Mike (09:42):
Yeah. I mean, I’ve been wrong on housing prices for years. I mean, no one should listen to be on it. But I try to look at the different options. What can happen to housing prices? They can’t go up. That doesn’t make any sense. There’s no way that we can have higher interest, and the housing market going to take off again. It may happen. I may be totally wrong. But I can’t see how it could. The other thing, unless people make a lot more money, it can’t really stay the same unless everyone starts to make 10 or 15% more. As you were talking about before, you’re going to have this extra big lump sum of money you’ve got to pay every year. Unless everyone gets a big raise, that’s not going to happen. The other-
Rob (10:17):
You might have to get a second job.
Mike (10:20):
Yeah. What are you left with? You’re left with housing prices taking a bit of a fall. I don’t know how far they’ll go or how long that will go, but that’s a good possibility.
Rob (10:32):
Are the banks the bad guys? Are they profiting from all of this, rising interest rates, and so on? Are they taking advantage of it?
Mike (10:42):
That’s something I think about a lot. With higher interest rates, the margins do get better for the banks. But the banks aren’t dictating the interest rates. Remember, interest rates come from the government. They’re controlling the money supply the banks have to react to that. The banks do make more profits off high-interest rates. But the one problem is the banks, for a long period of time, have not had to deal with a lot of mortgage foreclosures and bad debt. I mean, we have CHMC in Canada, which is a mortgage insurance, which helps out a bit, but there is still a lot of money lost if they have to start foreclosing on homes. It’s costly to the bank. Hopefully, that won’t happen in a lot of the cases, but if it does, the banks are going to start to have to have some bad debt built into the books.
Rob (11:25):
Which would be bad for bank profits. The banks may make more money because of the rising interest rates, but the downside is the foreclosures. Let’s go to the commercial side. How will that all work out? What about commercial real estate? It seems to be in a flux. We’ve got lots of people working from home. We’ve got lots of prime office space in major downtown cities that is 60 to 70% occupied.
Mike (11:53):
Yeah. It’s a shift because we’re short on storage. With all the warehouse and all that… They’re dying for storage space. We have a massive real estate shortage on that for warehousing. Then, we have a massive surplus on the office space. I mean, there has to be some type of reposition of real estate, I guess. I really don’t know how that all plays out. If you end up in a recessionary period again, the demand always drops during a recession, too, which can affect the commercial real estate prices quite a bit.
Rob (12:24):
We think the banks may take a little bit of a hit on personal mortgages and some foreclosures there. Who knows what happens on the corporate side? Some of those office buildings, if they’re too highly leveraged, may be in a difficult situation because they haven’t got the income coming in. They can’t survive on 60 to 70% of their income.
Mike (12:46):
Yeah. Well, hopefully, people start getting back to working in office soon. That would help that situation too.
Rob (12:50):
That brings us to the end of another week. Thank you for joining us. This is Rob and Mike with Think Smart from The McClelland Financial Group of Assante Capital Management, reminding you to live the life that makes you happy.
Assante Capital Management (13:25):
You’ve been listening to The McClelland Financial Group of Assante Capital Management Limited. Assante Capital Management Limited is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. Insurance products and services are provided through Assante Estate And Insurance Services Incorporated. This material is provided for general information and is subject to change without notice. Every effort has been made to compile this material from reliable sources. However, no warranty can be made as to its accuracy or completeness. Before acting on any of the previous information. Please make sure to see a professional advisor for individual financial advice based on your personal circumstances. The opinions expressed are those of the authors and not necessarily those of Assante Estate Management Limited.
