What if interest rates go up?

Question

I'm sure we all know central bank rates are quite low in Canada and the US, and I don't want to get burned if they go up in real terms at some point. When considering buying a property, do you make any allowance for interest rates to go up?

I'm house hacking now and considering spending around $20,000 to finish my basement and add a bedroom down there. So in my situation if my mortgage payment goes from $1,000 to $1,800 that would more than wipe out my cash flow.

Corey Hawkinson · Answer

@Travis Lucy I think about interest rates going up, but it is only 1 factor to consider. Personally, I don’t get overwhelmed by thinking about that. What numbers are you using that show your payment going from $1,000 to $1,800? That’s seems like way too high of a jump to only be caused by interest.

Roy N. · Answer

@Travis Lucy

You could arrange the purchase from your mother now - at present fair-market value - without having to pull a conventional mortgage {at least right away}.   You could provide a downpayment and either structure it with your mother as the lender {your would make mortgage payments to her} or structure it as an instalment sale (you still make payments to your mother,  but the property would remain in her name until you finish ... or re-finance with a conventional mortgage).   The two are treated differently by CRA ... so you and your mother would want to consult with an accountant to decide which approach works best for each of you (mostly for Mom) and then with an attorney to draw-up the mortgage agreement.

In the first instance (mom the lender), the house would be in your name and you would be able to make any modifications (finish the basement) without it impacting your acquisition price.   In the latter case (instalment sale), you would write in the sales agreement that you will be assuming all maintenance and care for the house - and that you have the right to modify or improve it, which would allow you to finish the basement without impacting your purchase price.

Theresa Harris · Answer

@Travis Lucy  If it is a full basement that you could rent it as a basement suite or extra rooms, you'd get you money back from that in a few years.  Write up a contract with your mom agreeing on the sales price of the home and that you can finish the basement now.  Not sure what state the basement is in. If you just put in bedrooms to rent, leave some space for a separate living area (and bathroom) plus a kitchen that could be added later.  then when you have more money saved up, add a second kitchen and close off the basement as a separate unit.

Sarah Brown · Answer

Everyone here has had excellent advice.  I have a few questions though.  If your current salary qualifies you for $200k mortgage, how are you going to qualify for $285,000 when you get your 5% down?

Also, are rooms really only renting for $180/mo?  Maybe do a little research and see if that makes sense.  Perhaps you are short changing yourself on your house hack.

You stated you wanted to wait until after you bought the property to do the basement repairs because it would increase the value of the house.  Did you agree to a set price with your mom on the house, or did you agree to market price?  In the states, the better your LTV the better off you are for you loan.  Canada may be a bit different.

Matt Higgins · Answer

I usually pay up for “interest rate insurance” (10 year fixed financing).  You shouldn’t buy a car from the only dealership you stop at and it helps to shop at least 3 lenders, and that’s 3 lenders that actually want your business.  One thing I wish I would have done earlier in my career is look over the actual loans docs closer.  What is your personal guarantee?  What if any properties are cross collateralized in the loan?  What is the prepayment penalty if you sell or find a better loan?  Finding long term financing and negotiation the above all give you flexibility which is nice if things get tight.

I don’t mind putting money into older properties.  If you keep them up and do the maintenance they will appreciate in value if the location is solid.  The tenants who call us ask how many bedrooms or square feet, never had someone ask me the age of the unit. Best of luck to you!

Travis Lucy · Answer

I'm probably in a pretty unusual position. My mom inherited this house when my grandma died a couple years ago. I'm house hacking it - along with not paying my mom rent - and I'm effectively homeowner but I don't have my name on the title deed. The plan is that I'll buy this house for $300000 when I can make a 5% down payment (the minimum in Canada).

Now - I think finishing my basement would jack up the house price, so I don't want to do the renovations until I've already bought the house.

I have a pretty small income, about $37000 including rent from my tenant, but I'm able to save about $8000 per year. With my income I'd qualify for about $200000 of mortgage right now. If we account for the $180 monthly extra cash flow after I build this bedroom and put a good tenant in it, my income would go up to $39000 annually.

Paul Moore · Answer

Travis.  It would be great to lock it in if you could.  But the long-term forecast on interest rates is encouraging. I read that the 10-year forecast is for little to no increase in rates. Here is a forecast for the next few years: https://longforecast.com/libor-forecast-2017-2018-2019

Huong Luu · Answer

In addition to what was said above, keep in mind rates usually go up by 0.25%-1.0% at a time and at specific times will the Bank of Canada consider increasing it, so it will take several increases for you to see the $800/m increase you are fearing. If you have the $20K now to do the reno, and can recoup that back in 3-6 months (either through rent income and equity pullout), then it makes sense to do the reno now.  Regardless if you are in a variable or fixed mortgage now, considering doubling up on your payments if you have cash so you can decrease the overall interest you are paying and when you refi, you should be able to access more equity via a HELOC.

What if interest rates go up?

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