What If Mortgage Rates Rise?
Rumour has it mortgage rates could be going up. The central bank has dropped some hints that a hike to the Bank of Canada interest rate, or overnight rate (the main policy interest rate in Canada) could be coming. The overnight rate has a direct effect on the prime rate, the rate on which variable mortgage rates are based.
It’s been a very long time since a Bank of Canada interest rate hike has happened. In fact, the last time the BoC raised rates was in September 2010. A lot can happen in seven years, so we don’t blame you if you forgot what happens if mortgage rates rise. Here’s a refresher:
If you already have a mortgage
There are a few possible scenarios for you if you already have a mortgage. Let’s start with the simplest scenario. If you have a fixed-rate mortgage, nothing will happen.
That’s it. Fixed rates are locked in for the entire mortgage term—most commonly five years. Your rate is guaranteed not to change in that time regardless of what happens in the market.
If your fixed-rate mortgage is up for renewal soon, you can rest easy because fixed mortgage rates are influenced primarily by bond yields, not the prime rate. And today’s best mortgage rates—fixed or variable—are substantially lower than they were five years ago. There’s a chance fixed-rate mortgages could rise, but not as a result of anything happening at the BoC.
If you have a variable-rate mortgage, however, you will be affected by a change in the prime rate.
When the prime rate rises or falls, variable mortgage rates rise or fall with it. In fact, variable mortgage rates are usually expressed as prime plus or minus a certain percentage. For example, if the prime rate is 2.7%, and your mortgage rate is prime minus 0.7%, you pay 2%. If the prime rate goes up to 3%, your mortgage rate would go up to 2.3%.
If the prime rate goes up, you’ll pay a greater amount of interest on the outstanding balance of your mortgage. In some cases, your monthly payment will increase to cover the additional amount. Let’s take a look at an example:
Imagine you bought a home for $750,000 (it feels good to dream), put 10% down and have a five-year variable mortgage rate of 1.75% (prime minus 0.95%). According to Ratehub.ca’s mortgage payment calculator, your monthly mortgage payment would be $2,864.
If your mortgage rate were to increase by 0.25 percentage points to 2%, your monthly payment will rise to $2,947—an increase of $83 a month or $996 per year.
If you have a variable-rate mortgage and you’re concerned about your ability to handle higher payments if rates go up substantially, you might consider talking to your mortgage broker about switching to a fixed-rate mortgage. You’ll pay a higher mortgage rate up-front, but you’ll be protected from further rate increases in case rates spike over the coming years.
If you’re shopping for a first home
If you’re a first-time homebuyer with a down payment of less than 20%, you can rest assured that your mortgage affordability will not change—at least not the maximum amount you can borrow.
That’s because your maximum affordability is usually based on the Bank of Canada’s benchmark qualifying rate, which is an average of the big banks’ posted five-year fixed rates. It’s currently at 4.64%—much higher than the rate a vast majority of Canadians should expect to pay.
A mortgage affordability calculator can help you determine how your maximum affordability changes depending on the mortgage rate you choose.
Even though the maximum amount you’re allowed to borrow may not change, you will want to consider how your variable-rate mortgage payment will change if rates go up because rates could rise at any time over the course of your mortgage.
The same example above applies. The monthly payment on a $750,000 home with 10% down at a five-year variable mortgage rate of 1.75% would rise by $83 per month if rates went up 0.25 percentage points. If rates went up a full percentage point, your payment would jump an additional $341 a month.
Odds are interest rates will go up at least a little bit over the next five years, so you should be prepared for your payment to increase if you choose a variable-rate mortgage. However, variable mortgage rates have historically trended lower than fixed rates over the long run. Even with the example above, the full percentage point rate hike to 2.75% wouldn’t be that much more than the best rate for a new five-year fixed mortgage today. And depending on how long it takes rates to rise by that amount, it could still work out that you pay less interest by choosing a variable rate. The choice between fixed and variable is a matter of your personal comfort.
What will the rate hike look like?
Historically, the BoC has raised and lowered rates in increments of 0.25 percentage points, and the banks have adjusted their prime rates in lockstep. However, there have been exceptions to this rule in the last few years.
The last two times the BoC rate has gone down, the banks haven’t passed on the full discount to customers. After each rate cut of 0.25 percentage points, the banks only lowered their prime rates by 0.15 percentage points. It’s possible that when the BoC rate goes up, the banks will raise their prime rates by only 0.15 percentage points, but it’s much more likely that they’ll pass on the full 0.25 percent point increase to their customers.
It’s also noteworthy that TD Canada Trust unilaterally raised its mortgage prime rate back in November, even though the BoC and other banks didn’t adjust their rates. TD could choose to raise its mortgage prime rate again and stay elevated above the rest of the big banks.
Chances are, if the BoC announces an interest rate hike on July 12, variable mortgage rates will increase by 0.25 percentage points.
But whether a rate hike is actually going to happen is also an important question. There are some analysts who don’t think an increase will come until much later this year, if not 2018.
Throughout the last several years, the BoC has stuck to one important metric: Inflation. The BoC’s mandate is to keep an inflation target of 2%, and in the past the bank has rejected calls to move interest rates for other reasons. All other economic indicators aside, the decision will come down to whether the BoC believes an interest rate hike is necessary to hold inflation to its target of 2%.
Regardless of what happens, your best defense against rising mortgage rates is to know your options and be prepared. If you’re worried, talk to your mortgage broker about how your mortgage payments would be affected by a rate hike, and what your options are for locking in a fixed rate.