Mortgages and Inflation: How Do They Affect Each Other?

This piece was originally published on May 11, 2022 and was updated on April 11, 2025. 

While Canada’s inflation rate has come down from its peak of 8.1% in June 2022, the headline number recently hit 2.6% in February 2025 (more than the Bank of Canada’s target range of 2%). Although we might not be paying eight bucks for a loaf of bread just yet, things still aren’t exactly cheap. Unfortunately, an increased inflation rate doesn’t just affect your shopping cart – it can also hit your mortgage. Keep reading to find out how inflation and mortgage rates are connected and what you can do to avoid being caught off guard.

What is the relationship between inflation and interest rates on mortgages?

Inflation is a natural part of a growing economy, but when it rises too quickly, it can create problems. As everyone races to raise prices to try to keep up, the value of the dollar can drop sharply. Left unchecked, it can cause a recession. In extreme cases, currencies have become completely worthless – to the point where it’s cheaper to literally burn cash than buy firewood.

The Bank of Canada has a mandate to keep inflation at a target rate of 2% per year to maintain economic stability. To do this, the Bank adjusts its overnight rate, which is the cost for banks to borrow money from each other (literally) over one night. When BoC raises this benchmark rate, lenders also increase mortgage rates to cover their costs.

How inflation affects variable mortgage rates

For variable-rate mortgages, the connection to inflation is direct. These rates are expressed in relationship to the bank’s overnight rate, which usually changes when the BoC adjusts the overnight rate. 

For example, let’s say your lender is offering variable mortgage rates at Prime – 1.0%. Because the prime rate is currently 4.95%, you would pay an actual mortgage rate of 3.95% (4.95% - 1.0%). If the BoC raises the overnight rate by 25 points (0.25%), and the bank raises its prime rate by the same amount, your mortgage rate will go up to 4.20%.

How inflation affects fixed mortgage rates

Unlike variable-rate mortgages, fixed mortgage rates aren’t directly tied to the Bank of Canada’s overnight rate. However, they still respond to inflation and interest rate changes. Fixed rates are more closely related to bond yields, which typically rise when inflation is expected to jump. When inflation increases, bond investors demand higher returns to compensate for the loss of money’s value. This causes bond yields to go up, which in turn pushes fixed mortgage rates higher as well.

How do interest rates affect inflation?

It’s not just inflation that impacts mortgage rates – interest rates can also influence inflation. Here’s how:

1. Impact on consumer spending: High mortgage rates make it more expensive to borrow money, which can slow down spending in the housing market and other areas of the economy. When fewer people can afford to buy homes, it reduces overall demand in the housing market, which in turn can lower inflationary pressure in housing-related costs, like rent and home prices.
   
   
2. Slower economic growth: Higher mortgage rates generally lead to higher monthly payments for homeowners. This can reduce disposable income, causing people to cut back on spending. When consumers spend less, it can reduce demand for goods and services, which may help slow down inflation over time.

February’s inflation data showed that mortgage interest costs rose 9% year-over-year, marking the 18th consecutive month of deceleration. Since MIC is one of the major contributors to overall inflation, this continued slowdown is a significant development to help ease inflationary pressures in the housing sector.

What do inflation and rising interest rates mean for my mortgage?

If you have a variable-rate mortgage, you’ve probably already noticed that your monthly payment has gone down due to the Bank of Canada’s rate cuts. Since June 2024, the BoC has implemented eight rate cuts, which have helped bring down variable mortgage rates. However, as interest rates remain fluid, your mortgage payment may continue to adjust in response to any further changes in the Bank’s policy.

While variable-rate mortgages are typically lower than fixed-rate mortgages, that’s not the case right now. With the current overnight rate at 2.75%, the best 5-year variable mortgage rate is 3.95%.

If you have a fixed-rate mortgage, your payment will remain the same until your mortgage is up for renewal. However, when it’s time to renew, you may face a higher rate. For instance, if you took out a 5-year fixed mortgage in April 2021 at 1.68%, you’ll be renewing at today’s best 5-year fixed rate of 3.74% — more than double your previous rate.

How are the recent U.S. tariffs impacting inflation and mortgages?

The impact of U.S. tariffs has been primarily noticeable on fixed mortgage rates, which are influenced by bond yields. The rapidly changing tariff narrative has caused the bond market to swing significantly. Investors tend to seek out the safety of government bonds in times of market uncertainty. This was the case after U.S. President Donald Trump announced aggressive 50% reciprocal tariffs on a number of countries on April 2nd, temporarily causing American – and, by extension, Canadian - yields to drop. At the time, the Government of Canada's five-year bond yield fell as low as 2.4%, a three-year floor. However, as deep market panic continued, investors even started to pull money out of the bond market, as they began to lose confidence in even the U.S. 10-year Treasury yield, which is considered to mark the global standard in terms of debt pricing and stable returns. As a result, five-year yields in Canada (which are greatly impacted by the U.S. 10-year yield)  increased to the 2.6-2.7% range. Lower bond yields initially helped bring fixed mortgage rates down over the course of February and March, but they are now likely to rise again.

In the case of variable rates, many economists initially expected the Bank of Canada (BoC) to cut its overnight rate again on April 16th by a quarter-point to combat a tariff-induced recession. However, the BoC has since indicated that it is less likely to cut rates. In fact, the BoC recently stated that it would have kept rates steady if it weren’t for the economic damage caused by tariff uncertainty. This means the BoC may choose to hold or increase rates in response to the economic impact of tariffs, which would drive up variable mortgage rates.

There have only been a few times in history that fixed-rate mortgage holders have come out ahead of variable-rate mortgage holders. This could be one of those rare times. However, if you’re thinking to switch from a variable to a fixed mortgage, consistent payments and stability should remain your primary motivation. 

Also read: How could US tariffs impact Canadian mortgage rates?

What can I do to navigate fluctuating mortgage rates?

Even though mortgage rates are rising, they still haven't peaked. Prior to the Great Recession of 2008-09, rates bobbed around the 5%-6% range. In the 1970s and 1980s, mortgage rates of 10%-12% were typical. Since it’s not inconceivable that mortgage rates could return to those levels, you may want to start making changes now to prepare.

Here are a few things you might want to do to prepare for rising mortgage rates:

• Start making extra mortgage payments: For the past few decades, low mortgage rates have made it easier to carry a larger mortgage balance. However, with rising rates, now may be the time to make extra payments to reduce your principal. Lowering your mortgage balance will help you save money on interest in the long run. Use a mortgage payment calculator to estimate how much your payment might be at a higher rate. If your regular payments increase due to rising rates, the extra payments you’ve made will reduce the overall amount you owe, making future payments more manageable.
• Renew your fixed-rate mortgage early: If you’re currently in a fixed-rate mortgage, you might want to explore renewing early. This could be a good strategy if your current term is close to ending, especially since fixed mortgage rates have dropped recently due to lower bond yields. If you’re close to your mortgage renewal date, consider shopping around and getting a rate hold. This means you can lock in today's rate for a certain period, even if you don’t officially renew your mortgage until later. A rate hold can help you avoid higher rates if they continue to rise in the coming months.
• Consider refinancing to a more affordable option: If you're finding your current mortgage payments increasingly difficult to manage, refinancing your mortgage to a lower rate could help. This option could be particularly useful if you have significant equity in your home and want to take advantage of more manageable monthly payments as rates continue to rise. However, refinancing often comes with some upfront costs. 
• Call your mortgage broker or lender: If you’re concerned that rising inflation and mortgage rates will make it difficult for you to keep up with your mortgage payments, proactively reach out to your mortgage broker or lender to discuss your options. They will be willing to work with you to find solutions to keep your payments affordable. For example, you may be able to lower your payments by changing your payment frequency, extending your amortization, or switching to a new lender. You can use our amortization calculator to see how adjusting your amortization period length might affect your monthly payments. Be sure to ask questions and remember you don’t necessarily have to accept the first offer.
• Do nothing: As long as rates continue to rise, your mortgage will become more expensive no matter what you do. Trying to time the market is nearly impossible. You might simply choose to carry on as you already are and let the current carry you rather than waste energy trying to swim against it.

The bottom line

We’ve been fortunate to avoid rising inflation and mortgage rates for decades, but our free ride is coming to an end. Rather than trying to time the market, your best course of action may be to start making additional mortgage payments to get used to a higher price and reduce interest payments for your future self. 

If things get really out of hand, ask for the help you need. Get in touch with your lender or mortgage broker for solutions that fit your unique needs.

Also read:

• Should I Buy a House in a Recession?
• Should You Switch From a Variable-Rate to a Fixed-Rate Mortgage?
• Is a Short-Term Fixed-Rate Mortgage Right For You?
• How to Save for a House in Canada
• 7 Tips to Get Approved For a Mortgage
• The Bank of Mom and Dad and Your Down Payment