The Bank of Canada has just risen their policy rate by a staggering 1%, the largest hike in 20 years. They were sitting at 1.50%, a rate that was left, according to them, “too low for too long”. The last time we seen a hike like this was in 1998 – and they aren’t expected to stop here.
Of course, the Bank of Canada’s rate will in turn impact the rate us Canadians get from lenders in reference to things like lines of credit and mortgages. Since Wednesday we have already seen two of the largest bank’s move to raise their benchmark response. Both TD and RBC have raised their prime lending rates from 3.7% to 4.7%. It won’t be long until we see the other banks following suit.
So, what does this mean?
The higher rates are going to be felt most directly on the housing market, with variable rate mortgages being closely tied to the central bank’s rate. We became accustomed to a booming housing market throughout the pandemic, but the direction turned as the central bank indicated that higher rates will be showing its ugly face.
A suggestion to potential home buyers is that they have their finances ‘stress tested’. If they do not pass the test, lenders will be forced to lower the amount that they will lend to them until a pass is acquired.
Let’s look at how a 1% hike will effect your mortgage payments.
Although 1% may not sound too steep, if we observe a $400,000 mortgage that is amortized over 25 years at a 3% rate, you will be making a monthly payment of $1,893. Now when we add the 1% rate hike, the payments jump to $2,104 a month. Can the majority of us afford to dish out an additional $211 per month? What if the rate went up another whole percent to 5%? This has your monthly payment sitting at $2,326 – a whole $433 more a month, $5,196 annually. This cost does not even include the excruciating increase to the costs of gas and food.
With a variable rate mortgage, you will see your monthly payments increase every time the bank decides to hike their rates. This is why a few people have switched to a fixed rate mortgage. You will definitely see an increase in your monthly payments, but you will have the peace of mind that they will not increase unexpectedly for at least the next five years. Fixed-rate mortgages remain unaffected until their next renewal date.
Is there any relief?
Unfortunately, there is no easy answer to this question. The central bank’s forecasting inflation will remain at 8% over the next few months, and with any luck, begin to decline toward the end of the year. The target rate to reach is 2% by the end of 2024.
As for the Bank of Canada, the next rate announcement is set for September 7. The governing council predicts that interest rates will need to rise further, adding that the pace of these rate hikes will depend on the central bank’s assessment of the economy and inflation.
One thing is for sure, climbing interest rates will definitely impact the economy and the lives of countless Canadians. If the Bank can be more cautious about more hiking rates, by stopping around 3%, they should be able to maintain some level of growth. For now, we just have to wait and see (and maybe take it easy on the spending in the meantime).
Contact our office to find what how this will effect your purchase, sale or refinance transactions.