How you can tackle your mortgage debt as a millennial

Low interest rates are encouraging millennials to pursue home ownership despite the rising house prices in Canada. For some, however, that might mean taking on significant debt, which can dramatically change their financial picture.

Scotiabank conducted a study in March 2021 that found that more than half of all Canadians believe now is a good time to buy a new home as a result of low interest rates. In fact, 23% of Canadians aged 18 to 34 have purchased a home within the past year. As well, 39% of Canadians say the pandemic has accelerated their plans to buy a home; this is double what was reported six-months earlier.

Housing debt in Canada is rising at the fastest pace recorded in more than a decade. Between April of 2020 and April of 2021, the average purchase price of a home in Canada increased by nearly 42% to more than $696,000. For those without that kind of cash readily available, this will likely mean getting a mortgage that can cover most of the purchase price. With the increasing prices, even with low interest rates, that can mean a pretty large mortgage.

Here's what you need to know before taking on mortgage debt.

Sometimes when you take out a loan your credit score takes an initial hit, but that isn't necessarily the case with mortgages. Instead of worrying about how your mortgage could affect your credit score, and your ability to borrow more later, it's more important to think about how to successfully manage a mortgage while still paying off other high interest debts. 

Since a mortgage is considered a ‘good debt’, speak to your advisor and create a plan to pay down student loans, credit cards and other high interest debts that could potentially negatively affect your credit score. 

Credit checks may be a potential area of concern. Whenever you request to borrow money, credit bureaus factor that request into your overall credit score. Those who shop around for a mortgage need to be careful that each inquiry isn't serving to reduce their credit score. Fortunately, there are ways for borrowers to avoid hurting their credit while shopping around for a mortgage lender.

When purchasing a home, it's important to understand how much of your income you can realistically afford to budget for your mortgage and housing costs each month. That's called your "debt to income ratio" and it could include monthly mortgage payments, property taxes, utilities, condo fees, and other monthly or annual expenses as compared to your monthly household earnings.

Most mortgage lenders recommend not exceeding 32% of your monthly household income for housing costs and not going over more than 40% for all monthly payments - mortgage payments, car payments, credit card debt and other loans. It's important to keep this ratio in mind as you consider the type of mortgage and how much you can afford. 

Just because interest rates are low, it doesn't mean you should take on more debt. The Canada Mortgage and Housing Corporation recommends staying as far below that 40% threshold as possible in case of unexpected costs. Doing so can also help homeowners maintain a strong credit score while managing their mortgage debt.

Between down payments and closing costs, moving fees and furniture costs, purchasing a home can put a major strain on your finances.

When shopping for a home it's important to keep some of the other costs that come with homeownership in mind, especially in the shorter-term. For example, closing costs can range from 1.5% to 4% of the purchase price to cover legal and administrative fees, land transfer taxes and more, associated with purchasing a home.

It's important not to max out your savings on the down payment. Unlike renters, homeowners need to keep a little bit of extra wiggle room in their budget for its upkeep - snowplowing, gardening services, repairs, renovations and more. When deciding which home you can realistically afford, be sure to consider all expenses that are part of the purchase in addition to the down payment and mortgage.

Once you own the home, you'll also have annual property taxes to consider. Those are calculated based on the value of your home and vary by municipality. For example, the residential property tax rate in Toronto for 2021 is 0.611013%, meaning the owner of a property valued at $1,000,000 in Toronto will be required to pay $6,110.13 in property taxes that year. Homebuyers purchasing property in a building with shared spaces or amenities may also be required to pay monthly condo/maintenance fees.

It's also important to consider how your mortgage and housing costs fit into the broader context of your financial future. Keep in mind, there may be unexpected expenses in the future, so you want to ensure that you’re leaving enough room in your budget to manage that.  

Your mortgage consists of two components. The principal is the amount you borrow to cover the purchase price of the home, and the interest is amount paid to the bank in exchange for supplying the mortgage.

Interest can be structured in two ways - a fixed rate or a variable rate. A fixed interest rate means that the interest paid to the mortgage lender remains the same until the end of the term. Variable interest rates, on the other hand, can fluctuate during the mortgage term based on market interest rates as set by the Bank of Canada Bank Rate.

Here's how that can work. Between 2005 and 2014 the Bank Rate dropped from 4.75% to 0.5% which allowed homebuyers using a variable interest rate in 2005 to reduce their costs over time. However, interest rates can be unpredictable and can increase, as they did between 2015 and 2018 from 0.5% to 1.75%, which would likewise make your costs rise over time. That can make it difficult to figure out whether a variable or fixed rate will be the lower-cost option long-term.

In early 2020, interest rates dropped substantially as a result of the pandemic, making it an appealing time to apply for a fixed rate mortgage. There is now speculation that interest rates could rise in 2022, which would not be the best news for homeowners with a variable interest rate, as they could see their mortgage costs increase in the coming years.

Fortunately, Scotiabank offers a tool to help home seekers understand the implications of changing interest rates within the context of their overall financial picture.

The Scotia Total Equity^® Plan (STEP) lets users compare mortgage solutions and can help protect against interest rate changes by combining mortgage solutions.¹

Higher interest rates, however, could help reduce the competition seen in today's hot housing market, which is why nearly half of Canadians support an increase to help cool the real estate market, according to a recent Nanos/Bloomberg poll.

Unpredictable interest rates are just one more reason why it's important not to overextend yourself when purchasing a home. Keeping a low debt-to-income ratio, a strong credit score, and a balanced budget are your best defence against a hot housing market, and the potential of rising interest rates.