As we begin to count the days and the hours to end of 2022, many Canadians are looking forward to closing this year off and looking forward to a brand new year. While there are many things that we can be grateful for, many are eager to leave 2022 behind. One of the major contributors, is the aggressive reactionary decision to raise the prime rate in Canada in order to curb the run-away housing prices. Seven, back to back prime interest rate hikes, has brought mortgage prime rates from a record low of 2.45% to an eye watering 6.45% that was recently passed earlier this December.

This article is not here to criticize or attempt to try to analyze what may happen to the housing market; as an entire paper could be written on the subject. This article is going to focus on the here and now, specifically, what can we all do in the interim to manage our household finances, as our housing costs creep higher. In certain circumstances, we have seen news articles claiming that for some households, these costs have risen to nearly encompass up to 70% of a household’s income.

In times of uncertainty, returning to fundamentals is just as important (perhaps more) than attempting to innovate new solutions to the crisis. All mortgages that were issued in the last 6 years have undergone the b20 guidelines. Meaning all of them have been stressed tested and scrutinized based on the applicant’s income to debt ratios. While it’s true that the accelerated increase in interest rates have and will increase mortgage payments, but it’s important to recognize that not everyone will be impacted equally. Those who will be hit harder unfortunately are the new buyers that have had to really stretch their budget and rely on CMHC programs to complete their purchases. While there is nothing inherently wrong with the CMHC programs as they are in place to help individuals get into the housing market, the fact remains that the CMHC programs allow up to a minimum of a 5 percent down payment. Pair this with the fact that the amount of mortgage that you qualify for was typically 5x your reported income, it helped many Canadians step into home ownership. However, it also acts as a double-edged sword during times of increasing interest rates, due to the fact that an increase in interest rates will decrease the amount of mortgage you qualify based on your income. Specifically, while a few months ago, your income can ‘afford’ you roughly 5x the mortgage amount, now it’s down to around 4x, meaning that the income you had a few months ago is not able to sustain the same level of debt today. With mounting interest rates, and potential for a few more hikes, we put together a list of things you can consider in order to help protect your financial bottom line.

1.     Adjust your cash flow and budget: The Bank of Canada has set that all household expenditures cannot exceed more than 44% of total debt servicing. Meaning out of a household income,  if the housing expenditure is kept to 44% of income, than a household has the remaining 56% to allocate towards other household needs. In other words, our housing policy suggests that families can spend a little more than half of their income and still remain within the 44% debt servicing ratio. This however is not the case anymore due to the interest rate increases; this ratio is now starting to creep up. As such, based on the interest rise, the recommendation is to prepare oneself for a budget cap of 50/50. Meaning households should prepare themselves to put away at least 50% of their income in order to meet their housing expenditures should it also reach that level.  
 

2.     Prepayment Privileges: It may seem like a tall order to suggest prepayments when interest rates are on the rise, but remember that interest payments are calculated by multiplying the interest rate by principal. It is the principal now that we want to focus on, and the truth is that approximately 15% of Canadians with a mortgage have indeed followed the b20 guidelines and have had to save up for a 20% down payment for a home purchase. As such, if you have followed the above guideline and prepared for 50% of your income to go towards your mortgage, this is the time to utilize your prepayment privileges. If you have a traditional principal and interest mortgage, typically you have some prepayment privileges of paying between 10% up to 20% of your monthly frequency payments. If this payment is made, 100% of the payment is deducted from the principal balance of the mortgage. The lower your principal, the lower your overall payment will be, reducing your overall interest cost.

3.     Segregate/Restructure your debt: Once again, this one seems counterintuitive, as the common advice is to either consolidate your debt, or target the debt with the highest interest rate. However, understanding how your debt is structured in many ways is more important, as it will reveal what is the most efficient way of paying down debt. The flaw with just paying down the highest interest rate first is that it assumes that the highest interest rate debt will cost you more right? Not exactly, the amount of the debt also plays a significant factor. For example, a $100 dollar credit card debt at 18% is still going to cost you less than a $10,000 loan at 5%. While this may be obvious, what is less obvious is how those debt instruments are structured. Another example is your typical average mortgage. Most mortgage are what we call front loaded interest products. So let’s say you have a mortgage of $300k, and your interest rate is 5%. Your payment will roughly come up to $1744 a month (assuming a 25 year am). However, not all of that $1744 is going to be offset against your principal balance. In fact, near the beginning of the debt, over $1200 is allocated towards interest, whereas the remaining $544 will than be applied to the principal debt. Most banks offer some sort of Equity line of credit option that can be tied to your mortgage. While an equity line of credit does have a higher interest rate, it is not a ‘front loaded’ interest product, so if you were to apply the same payment as above, the entire payment will be deducted off the principal amount with the interest cost being calculated on the new lower balance. As such, restructuring your mortgage to have one portion to be an equity line, can give you much more flexibility and control in paying down your mortgage, or likewise, controlling the ‘cost’ of the mortgage as well.

4.     Increase your amortization schedule: Most people have stuck to their original mortgage terms when they first purchased their home. If you find that after instituting all of the above strategies and cashflow is still tight, than it is time to speak to your lender. Being honest with your lender may give you options that may help you hold through until the environment eases. A few common options are increasing your amortization to 30 years (in some cases lenders can go above this given certain exceptions) will generally help keep the payments at a more tolerable level. Lenders can also hold back on a portion of your payments so that it relieves the pressure of the increase payments, or even defer payments or sometimes add the missing payments to the balance of the mortgage. Speaking to your lender will give you an idea of the options you may have to help you sustain and carry on with your mortgage.

While Canada is still facing some uncertainty in the upcoming New Year, there have been several ‘silver linings’ that have presented themselves. Buying a home has always been a long term investment from our perspective, as such the opportunities to generate revenue from your own home has never been so promising. With the onset of the pandemic ushered the acceleration of remote work or at least the tolerance for more of this occurring and growing to be more common place. As such, those who can work remotely from home have the ability to not just earn revenue being at home, but also cut certain expenditures related to travel, commuting, and in some cases even save on office rent. In addition to this, Canada is really trying different policies such as garden suites, in-law suites to help open up more housing for the growing population. As such, many have found ways to include a secondary suite in their home that can act as an income generator helping with cash flow.  If any of these strategies speak to you or you would like to learn more, we encourage anyone who feels that they need support during this time to reach out. It is important to understand we all stand together and no one is alone.