Get ready, mortgage borrowers — the interest rate is on the rise again.
The Bank of Canada (BoC) has hiked its Overnight Lending Rate — the benchmark used by Canada’s big banks to set their own pricing — by a quarter of a per cent, to 1.75 per cent.
It’s the third increase this year, spurred by stabilizing consumer debt, improved economic performance and — most notably — the newly-minted U.S.-Mexico-Canada Agreement (USMCA).
The previously beleaguered trade agreement has now been solved, so it removes the main hurdle for the BoC, which held off hiking rates in recent months as trade doubts lingered.
“The new [USMCA] will reduce trade policy uncertainty in North America, which has been an important curb on business confidence and investment,” the BoC states in its announcement.
The central bank also expects Canada’s economy to continue to grow in line with its potential, with GDP to rise by 2.1 per cent this year before slowing to 1.9 per cent by 2020.
New oil and gas projects, along with steady household spending, have also supported inflation which remains 0.2 per cent above its target.
Tighter Times Ahead For Borrowers
The BoC acknowledges that higher interest rates are taking a bite out of consumer budgets, though maintains new borrowing policies, such as the mortgage stress test introduced this January, are being effective in stabilizing household credit levels. It strongly alludes that more hikes are to come, though it will take into account how tougher borrowing conditions will continue to impact both home buyers and the economy.
“Given all of these factors, Governing Council agrees that the policy interest rate will need to rise to a neutral state to achieve the inflation target,” the BoC states.
“In determining the appropriate pace of rate increases, Governing Council will continue to take into account how the economy is adjusting to higher interest rates, given the elevated level of household debt. In addition, we will pay close attention to global trade policy developments and their implications for the inflation outlook.
How Will This Affect Your Mortgage?
Rising rates will spell tighter affordability for borrowers of all kinds, as it will become more expensive to qualify for and carry a mortgage.
Today’s hike, compounded with the anticipated increases to come, will especially be felt by first-time home buyers, who are entering a rate environment that — while still historically low — is higher than they’ve ever experienced before
Variable mortgage holders will be most immediately impacted, as their lenders will pass this increase down into their monthly payments. However, a higher BoC rate translates into higher Prime rates at Canada’s largest financial institutions.
Assuming these lenders pass the entire 0.25 per cent to increase into their Prime to 3.95 per cent, a borrower taking out a new five-year variable-rate mortgage today on a home valued at $487,000 (the average Canadian home price as reported by CREA) can expect to pay $65 more per month than at the previous Prime rate of 3.70 per cent.
That’s $780 more per year, and a whopping $19,500 over 25 years.
As well, higher rates at Canada’s big five will in turn influence the Bank of Canada’s benchmark five-year rate, which is used as the threshold to stress test mortgage borrowers, meaning applicants will qualify for an even smaller mortgage amount than they did before.
For example, a home buyer earning $100,000, making a 20 per cent down payment and taking out a 30-year amortization, would qualify for a maximum home purchase of $523,772 under the current stress test rate of 5.34 per cent.
Assuming the benchmark rate increases by 0.20 per cent to 5.54 per cent, that same home buyer would then qualify for only $515,011 to $8,761 less towards their home budget.
Should rates rise to six per cent by 2020, as some pundits have predicted, that qualification amount is slashed by $50,000 — not small peanuts when it comes to funding a home purchase.
How Can Home Buyers Prepare?
Prospective buyers — especially those borrowing at their maximum — who are currently on the fence about their home purchase are wise to lock into a pre-approval ASAP, as policymakers usher Canada into a higher-interest-rate reality.
For existing mortgage holders, it’s time to hit the budget book and ensure that should interest rates be materially higher upon renewal, they can still afford their monthly payments.
Those who have the flexibility to accelerate their payments, or pay a lump sum now, may find that to be of benefit, as that will reduce their overall amortization and boost their mortgage principal.
It’s always a great idea to connect with a mortgage broker or adviser prior to starting your home search. They will help establish the ceiling for your home budget and affordability expectations; important peace of mind, especially during a rising rate environment.