Despite the Bank of Canada’s key overnight interest rate target holding steady at 0.25 per cent, the bank has signalled that interest rates are expected to rise, and soon.
An increase in the cost of borrowing will undoubtedly impact a number of homeowners, said Robert Hogue, a senior economist with the Royal Bank of Canada. He expects interest rates to rise gradually throughout the year and into 2023, he said, resulting in a cumulative impact on Canadian homeowners depending on the type of mortgage they have.
“The impact on the housing market itself will not be huge initially,” he told CTVNews.ca in a phone interview on Jan. 26. “The real impact will be the cumulative increase of those rate hikes, that’s ultimately what matters.”
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According to Hogue, Canadians could see as many as four interest rate hikes this year, each comprising an additional 25 basis points. By the second half of 2023, the interest rate is expected to reach 1.75 per cent, he said.
“We want to clearly signal that we expect interest rates will need to increase,” said Bank of Canada Governor Tiff Macklem in a press conference on Jan. 26. “The timing and pace of those increases will be guided by the bank's commitment to achieving the two per cent inflation target.”
Some experts suggest these increases could start as early as March, but Moshe Lander, an economics professor at Concordia University in Montreal, said he anticipates the first hike will take place in the second half of this year.
Those with fixed-rate mortgages are unlikely to feel the effects of an interest rate hike soon after it’s implemented, said Lander, particularly if their agreement was signed six to 12 months ago and extends for several years. According to a consumer report published by Mortgage Professionals Canada last year, 77 per cent of mortgages for homes purchased in 2020 were fixed-rate.
Homeowners who are especially sensitive to interest rate hikes include those with variable-rate mortgages and home equity lines of credit (HELOCs), said David Macdonald, a senior economist with the Canadian Centre for Policy Alternatives.
“A lot of Canadians with mortgages are not going to see this impact immediately,” Macdonald told CTV News Channel on Jan. 26. “[But] it's pretty clear that Canadians with variable-rate mortgages or home equity lines of credit are going to see this first in terms of increased payments.”
When the Bank of Canada’s overnight rate changes, chartered banks will adjust their prime rates, which then impact variable rates, Hogue said. If the central bank’s policy interest rate were to rise, Canadians could expect variable rates for mortgages to increase in lockstep either instantaneously or in short order, he said.
Ron Butler is a mortgage broker based in the Greater Toronto Area, and the founder of Butler Mortgage Inc. A majority of Canadian homeowners with variable-rate mortgages can expect to see an increase in their monthly payments within the month following an interest rate hike by the Bank of Canada, he said.
But the remaining portion – which Butler estimates to be 40 to 45 per cent of Canadians – likely won’t see a change in their payment total, but instead a reduction in the amount of principal being paid. While the mortgage payment stays consistent, Canadians in this situation would be paying more in interest based on increases implemented by the Bank of Canada. This could then impact the amount of time it would take to pay off their mortgage.
“When interest rates go up, they're going to pay a little bit more interest and relatively less principal,” Hogue said. “The overall payment is the same but you're just extending your amortization over time.”
HOW MUCH MORE COULD CANADIANS PAY?
For those with variable-rate mortgages, a rise in interest rates could result in a significant increase in mortgage payments after just one year.
According to Cannex, a Toronto-based company specializing in collecting financial data, the average rate for a five-year variable mortgage across all major Canadian lenders is 2.26 per cent. Still, it’s possible for a highly qualified borrower to lock in a variable rate as low as 1.25 per cent, Butler said. Based on data compiled by the Canadian Real Estate Association in January, the average price of a house in Canada is about $748,500.
Using the example of a five-year variable mortgage with a rate of 1.25 per cent, a down payment of 10 per cent and an amortization period of 25 years on a home that costs $748,500, the mortgage payment amounts to $2,696. After an increase of just 0.25 per cent in the mortgage rate, the total payment rises to $2,776, a difference of $80. This amounts to an increase of $960 per year, according to data from RateHub.ca.
Those still paying off HELOCs are also expected to feel the impact of rising interest rates, and fast. Survey data compiled by Mortgage Professionals Canada in 2020 shows that the average approved HELOC is $166,000, although balances can range up to a million dollars, Butler said. With minimum monthly payments based solely on interest rates, consumers would quickly feel the pinch of rising rates, he said.
“There's about four million Canadians with home equity lines of credit, and they would see an increase immediately,” Butler told CTVNews.ca in a phone interview on Jan. 26.
Not only could rising interest rates mean higher mortgage and line of credit payments, but they could also discourage some Canadians from entering the housing market in the first place, said Jason Mercer, chief market analyst for the Toronto Regional Real Estate Board. Those who find themselves on the “margin of affordability” when purchasing a home may opt not to do so at all, he said.
Rising rates could also have an impact on the types of decisions made by potential homebuyers, which may include seeking out different types of houses or locations that better fit a buyer’s budget, said Mercer.
“We've obviously seen very strong increases in home prices and… a real constrained supply,” Mercer told CTV News Channel on Jan. 26. “So a lot of homebuyers have looked further afield in terms of purchasing a home that meets their needs on an affordable basis.”
HOW TO PREPARE FOR A RISE IN RATES
One factor that may help soften the blow of higher interest rates to come are stress-test limitations, said Mercer. The measure, first implemented in 2018 by the Canada Mortgage and Housing Corporation, requires homebuyers to qualify at a higher interest rate than necessary to get a mortgage.
“If you're qualified at two per cent for your contract mortgage rate yesterday, and seeing the rate had gone up by 25 basis points… chances are you'd still qualify because you'd actually be qualifying regardless at five and a quarter per cent,” Mercer said. “A lot of households, at least on paper, would still qualify for a mortgage, even in a rising interest rate environment.”
The Bank of Canada is expected to make another interest rate announcement on March 2. In the meantime, Macdonald advises Canadians with variable-rate mortgages and lines of credit to look into fixed-rate options and consider making the switch.
“In the last couple of years, the spread between variable and fixed-rate mortgages has been relatively small and so fixed-rate has been a more popular option,” said Macdonald. “If you do have a home equity line of credit that's variable, now would be the time to examine how you might want to reduce the amount in that line of credit.”
While fixed rates will generally be higher than variable rates, Lander said, the extra cost may be worth it to those who would prefer to avoid the uncertainty that comes with variable-rate mortgages.
“You don't have to worry about when the bank is going to hike rates, how much they are going to hike and how fast,” he told CTVNews.ca in a phone interview on Jan. 26. “At least you know that you don't have to worry about all of these changes, and what it means for you.”
It’s also important that homeowners do their research and contact a mortgage broker if they have any questions, Lander said. He also advised reflecting on lifestyle choices in order to accommodate for increases in future mortgage payments.
“Interest rates are not going down anytime soon, they're only going to go up.”
