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Housing affordability: What happens when lower home prices take on higher borrowing costs?

The following table represents two scenarios: home owners with a 10% down payment, and those with a 20% down payment. Mortgages with a 20% down payment generally have higher interest rates because they are not eligible for mortgage default insurance. However, a home owner who puts down less than 20% will have to account for the added insurance costs. 

Thanks to Gina Athanasious, a RE/MAX real estate expert, for her help with the following calculations. 

(with average home price)
5-year fixed
(10% down)
5-year fixed
(20% down)
5-year variable
(10% down)
5-year variable
(20% down)
Rate Payment Rate Payment Rate Payment Rate Payment
2.59% $3,326 2.79% $3,022 0.90% $2,736 1.25% $2,536
4.79% $3,414 5.04% $3,110 2.50% $2,685 2.80% $2,467
4.34% $3,100 4.59% $2,827 3.50% $2,838 3.85% $2,619

The scorecard shows that, from February to June, variable-rate costs improved modestly, with falling home prices outweighing higher interest rates. Redo the same calculations for the 2022 period of February to July, however, and we see that variable-rate costs worsened, with higher interest rates now outweighing the drop in home prices. 

The opposite is true for fixed-rate mortgage costs. Those costs worsened between February and June but improved modestly between February and July. That said, head-to-head, variable rates seem to remain the more cost-effective option. 

Factoring in the mortgage stress test

The mortgage stress test, which sets a minimum qualifying rate for new mortgages, requires borrowers to prove they can handle their mortgage payment at the greater of 5.25% or their contract rate plus two percentage points. 

With many variable rates now sitting at just north of 4%, many buyers are having to qualify for a mortgage at 6% or higher, rendering the 5.25% threshold essentially not applicable. And now that fixed mortgage rates have increased by two-thirds in just four months, many people applying for fixed-rate mortgages are facing stress-tested rates of around 7%, on average. 

This, too, is putting downward pressure on the housing market. 

James Laird, co-CEO of Ratehub Inc. and president of the mortgage lender CanWise (which is also owned by Ratehub Inc.), explains that generally, for every 1% that the stress test increases, a household qualifies for about 10% less mortgage. “Home prices will need to drop significantly in order to neutralize the effects that higher mortgage rates have on the stress test,” Laird shared in a statement. “Unless this happens, home affordability will continue to be impacted significantly by the current rising rate environment.” 

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