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Housing values tied to affordability and future interest rates 17 · Thursday, November 29, 2012 OAKVILLE BEAVER · www.insideHALTON.com T he question of what will happen to the value of your house is a popular one these days. Those planning for retirement wonder what amount of cash they will be able to add to their investments from the sale of their house in order to provide for their future financial needs. Predicting the future value of any asset is ultimately a guess but with real estate, there are some potential warning signs that should be considered now. These warning signs should be viewed through the eyes of a potential buyer. The value of your house is based on what a buyer will pay. Consumers buy items based more on what they can afford than on the actual price. For example, cars are sold on the easily affordable monthly payments versus the actual price. Housing purchases are based on what the prospective purchaser can afford. Many will get preapproved for a specific value of mortgage. Buyers often purchase the most expensive house they can afford to carry. This is where the term "house poor" originates from. Much of the family cash flow goes to servicing the house mortgage and other housing costs. We will work through the arithmetic of home ownership as a way of looking at the potential future value of a house. The average house price in Oakville, as of September, was just under $663,000, according to The Oakville, Milton and District Real Estate Board. If that average house had a mortgage worth 75 per cent of its value, that would amount to $497,250. According to the TD Canada Trust website, the rate of a five year fixed term mortgage is 5.24 per cent. Mortgage payments include interest payments plus some repayment of principal. To simplify this example we Dollars & Sense By Peter Watson sive to carry because interests have increased, there is the potential for values to decrease. Many investors assume the value of their house will only increase. That is a fair thought given the recent rise of real estate over the past several decades. Many compare that real estate stability against the volatility and uncertainty of stock values, since the U.S. economy pushed the world into a recession in 2008 -- their real estate values plummeted. Real estate does not come with any guarantees. Values can change both up and down. One factor affecting future values will be affordability and that is dependent on future interest rates. -- Submitted by Peter Watson, MBA, CFP, R.F.P., CIM, FCSI. will eliminate the principal repayment so our figures of actual costs will be understated. For a mortgage of $497,250, the interest payments would be $26,055 per year. Mortgage interest payments are likely paid from earned income, so it is beneficial to consider what amount of your income is needed to afford these debt payments. Assume your income is taxed at a rate of 30 per cent. You would have to earn $37,220 annually just to pay the $26,055 interest expense on your mortgage. This is where the potential problem starts. What happens when rates increase? Current interest rates are at historic lows. At some point we should assume they will increase. What happens if rates double? Now the income needed to make interest payments on an averaged priced house in our community will double from $37,220 to $74,440. Will houses be affordable at their current price or will prices have to decrease? There is little chance that your income will increase enough to absorb a doubling of interest rates, so the only solution would be to have a smaller mortgage, which means paying less for a house. In our current world of expanding our purchasing power to allow us to consume more, we have to realize the affordability of a house will greatly affect its saleability. 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