There is no way that interest rates can rise sharply without a high degree of unfairness in how people are affected.
Take borrowers and savers, for example. If you owe a lot on a mortgage, rising rates can increase the cost of your payments by hundreds of dollars a month. Meanwhile, savers are generating more interest in their bank accounts and guaranteed investment certificates than they have in decades. Five per cent returns are there for the taking right now.
This distinction is helpful in explaining how young people who recently bought first homes are hit the hardest by rising rates. A generation of homeowners was traumatized by the interest spike of the early 1980s. What’s happening to young owners today is the sequel no one asked for.
Some help for young adults is coming through the federal government’s plan to eliminate interest on current and future federal student loans on April 1, and the gradual rollout of its $10-a-day child-care program. But what recent first-time home buyers are up against is bigger than that.
They’re paying more to own expensive houses that in many parts of the country are worth less and less. Unless rates peak soon and then head lower, the financial arc of their lives could be changed for the worse. Later retirements, for example. And, less ability to help their own kids with money for postsecondary tuition and home down payments. Financial help for aged parents might also be limited.
What makes young homeowners so vulnerable is that they bought houses at peak pricing levels and had little opportunity to pay down their balances before mortgage rates started rising. Close to half of recent buyers have variable-rate mortgages, an informal survey done through the Carrick on Money newsletter shows. So far this year, the Bank of Canada overnight rate, on which these variable mortgage rates are based, has increased six times by a cumulative 3.5 percentage points.
These rate hikes are applied against the jumbo-size balances of recent buyers, as opposed to the much pared-down mortgages of people who have owned for many years. We hit peak housing in February, with an average national resale price of $816,720. Around that time, there were about nine cities or regions with average prices of close to $1-million or more.
In our housing survey, almost 52 per cent of people who have had their mortgage payments rise pegged the amount of the increase at more than $500 a month. Most young families don’t have the financial slack to cover that amount without sacrificing something.
If your response to that is a shrug, consider this. Every purchase a family forgoes is money taken away from a business that employs people and pays taxes. Every dollar of retirement savings forgone adds incrementally to the risk of a coming generation of seniors who aren’t as financially secure as we all want them to be.
Don’t underestimate how aware young adults are about retirement saving. We’re halfway through the sixth season of our Stress Test personal finance podcast for Gen Z and millennials and our most listened-to episode ever was about retirement. Our home-buying episodes had lots of listeners, but retirement topped them.
There’s a financial payoff to higher rates that we sometimes underplay against the misery of higher debt burdens. If you’re saving or investing conservatively, you can now make comparatively good money on a risk-free basis. Unfortunately, young homeowners are perfectly positioned to get nearly no benefit from higher rates, even as they have maximum exposure to rising borrowing costs.
Your worst years for saving are the ones after you buy a house and start a family. That’s okay – you can catch up later. But we’re in a golden age for saving right now and it won’t last.
Mortgage rates topped 20 per cent for a short while in the early 1980s, an epic moment in the history of Canadian personal finance. Mortgage rates today are between 5 and 6 per cent, but that’s a doubling of rates from 12 or so months ago.
Also, home prices now are much higher than they were decades ago. The average national resale house price in 1980 was $67,024, which works out to $227,435 today if you adjust for inflation. The most recent comparable number, for September, was $640,479.
The who-had-it-worse standoff between boomers and today’s young adults is a dead end. What is indisputable is that today’s numbers tell us that rising interest rates hit young adults hardest.
PERSONAL FINANCE COLUMNIST
The Globe and Mail, November 14, 2022