If you recently bought a home or an apartment block, did the reality of the first mortgage payment sap your strength? Take comfort that low mortgage rates are helping to build equity and personal wealth more rapidly for Canadian borrowers than any time since at least 1951.
On a new mortgage taken at today’s rates and 25 year amortization, it is certain that over 50% of your first payment will be allocated to the repayment of the original loan amount. Decrease the amortization period and the effect is even greater. In past years when rates were 10%, only a shocking 9% of a first mortgage payment would be allocated to the pay down of principal.
This function of math has a powerful implication to homeowners, real estate investors and the Canadian economy. Current low interest debt is better than high because more principal gets paid back by the borrower per payment, starting immediately in the amortization of the loan.
If someone buys a house for $300,000 today at 2.75%, their first mortgage payment will allocate 50.5% of that payment to principal and 49.5% to interest. In five years, $44,819 would be paid down or 14.93% of the original loan. In 14.58 years their mortgage would be half paid off.
This is a huge deal to the borrower if only in observing their debt immediately decline on their bank statement and realizing they owe significantly less with every payment, from the beginning.
Contrast this to the days when a mortgage interest rate was 10%. People forget that for 23 years from 1969 to 1992 an average 5 year, residential rate was at least 10% and for 15 of those years it was 11% or higher. Back then, only 8.72% of a first payment would go to principal pay down and 91.28% to interest. It would take over 18 years of payments before 50.5% of the payment was being allocated to principal as it would be today, and in five years only $18,000 would be paid down or 6% of the original borrowed amount. Also, it would take almost 19 years before half of the original mortgage amount would be paid. Today we wipe out 2.49 times more principal owing in the first five years than in the past.
As a borrower in higher rate days, you could be excused for feeling that you had dug yourself a hole that you would never get out of and as a consumer this could undermine not only your confidence in real estate as a performing asset but it would likely impact your buying habits, creating broader effects on the economy. As an investor, at best it may slow your desire and ability to buy another property thus decelerating the actions of you and other investors in the economy.
Having a population of real estate owners who feel better, quicker, about the pace they are paying down their largest debt is a powerful force that may reflect through to Consumer Confidence of the nation.
The Conference Board of Canada performs a quarterly survey that poses four questions in estimating the Canadian Index of Consumer Confidence (ICC). These questions are:
- Considering everything, would you say that your family is better or worse off financially than six months ago?
- Considering everything, do you think that your family will be better off, the same or worse off financially six months from now?
- How do you feel the job situation and overall employment will be in this community six months from now?
- Do you think that right now is a good or bad time for the average person to make a major outlay for items such as a home, car or other major item?
Personal debt perception will directly impact the way respondents answer at least three (#1, 2 +4) of the four questions, thus potentially moving the survey result and affecting government policy. We hear about Canadians piled with debt but little is written how math is accelerating the rate at which this debt is being paid down.
Daryl Benoit AACI, CCIM
Daryl Benoit Real Estate Appraisals
Winnipeg IC&I Valuation Specialist
Daryl Benoit is a commercial real estate appraiser involved in the Winnipeg, Manitoba, Canada market for over 28 years. He is recognized by the Appraisal Institute of Canada as an AACI and by the CCIM Institute as a CCIM.
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