In today’s announcement, the Bank of Canada increased its overnight rate by 0.75% to 3.25%, its fifth consecutive hike in its campaign to regain control over inflation.
What exactly is this interest rate and why is it important?
The Bank of Canada meets eight times a year to review the overnight rate, which influences the Prime Rate, the annual interest rate Canada’s major banks and lenders use to set interest rates for variable rate mortgages, lines of credit and student loans.
These announcements about potential rate changes could impact your current and future borrowing plans. I am here to provide you with strategies to get you on track with your financial goals and make sure that the impact of any interest rate changes to you is minimal.
Why did the Bank of Canada increase this rate?
In today’s announcement, the Bank of Canada increased its overnight rate by 0.75%. The bank said the effects of COVID-19 outbreaks, supply chain disruptions, and the war in Ukraine continued to dampen economic growth in Canada and boost prices. The bank also noted its Governing Council still judges that the overnight rate will need to rise further to achieve the 2% inflation target.
The Bank expects the Canadian economy to “moderate” in the last half of 2022 as global demand weakens and tighter monetary policy begins to bring demand more in line with supply. As the effects of tighter monetary policy work through the economy, the bank will be assessing how much higher interest rates need to go to return inflation to target.
What does this mean for your mortgage?
Adjustable Rate Mortgage (ARM)
If you’re in an adjustable rate mortgage, where your payment changes with the Prime Rate (the most common type of variable), you will see your mortgage payment increase. The Prime Rate will increase from 4.70% to 5.45%. The cost impact is for every $100,000 you owe, your monthly mortgage payment will increase by approximately $40.
Variable Rate Mortgage (VRM or VIRM)
If you’re in a variable rate mortgage, where your payment is static, more of your payment will go towards interest and less towards principal.
As interest rates on variable rate mortgages increase and the payments don’t change, there will be a point where the payments can no longer cover the accrued interest. This happens when your rate has exceeded the Trigger Rate. Your lender will advise you if this happens and you have to increase your payment, make a lump sum and/or switch to a fixed rate with a higher payment.
What to consider before locking into a fixed rate mortgage?
If you lock into a fixed rate now and rates come back down, which logic and history indicate they will, then you will only be able to take advantage of the lower rates by paying a very large penalty to get out of your term. As the market fluctuates, within those fluctuations there is often an opportunity to save some money in a variable and pay more to your principal.
The penalty implications of breaking a fixed rate mortgage if you wish to sell, refinance or early renew before the end of your term.
If your budget can handle any further increases to your monthly payments.
What does this mean for the stress test & qualifying?
The stress test is a set of rules lenders must use to determine if you qualify for a mortgage. You have to prove that you can still make your monthly mortgage payments if interest rates were to rise in the future.
Whether you choose a fixed or variable rate mortgage on your next home purchase, renewal or refinance, you will be stress tested at your contract rate + 2%. With the increase in variable rates today and fixed rates soon on the rise, this will have a direct impact on how much you can afford.
What does this mean for new home shoppers?
If you’re in the market for a new home, you should get pre-approved in order to determine your budget and hold today’s rates for up to 120 days while you search for a home. This will protect you from any further rate increases during that time.
A pre-approval will also put you in a position to instantly make an offer to purchase. This will show the seller that you have your financing in order and are ready to buy.
I can completely understand the concern around rates and what is going to happen when it comes to your affordability. You may wondering “what is going to happen to my payments? What are my options for my renewal coming up? Will I be able to afford to buy a home?” These are all valid and real concerns. We can absolutely review your mortgage, financial situation and your options.
I just want you to know that while it may feel overwhelming right now, everything will be okay. The media instills fear with the news-worthy panic they create but be sure to review your numbers and household budget and always consult the financial professionals, that’s what we are here for. If you have questions about what this change means for you, please don’t hesitate to reach out.
The next Bank of Canada announcement will take place on October 26, 2022.
Tatum Neufeld, BComm
Mortgage Broker • Mortgage Tailors