On October 26th, the Bank of Canada increased the overnight rate by 0.50% to 3.75%. The increase came in lower than the market was expecting. The majority of market watchers had predicted a 0.75% increase. The smaller than expected increase appears to be an indication the Bank of Canada is nearing the end of this rate-hiking cycle. But it is not done yet.
“This tightening phase will come to a close. We’re getting closer to that point, but we’re not there yet. So we do expect interest rates will need to go up further,” said Bank of Canada Governor Tiff Macklem following last week’s rate announcement.
Although further rate hikes will most likely still be necessary, the Bank mentioned that future rate increases will be based on its assessment of how all of their rate increases this year affect the economy. So far, the bank has raised the overnight rate six times already this year.
Macklem also indicated future increases would likely be smaller than what we have seen so far this cycle. That leaves the door open for another increase at the next, and final, setting for the year, in December. Several forecasts predict the Bank will pause at 4%.
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 adjustable/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.
What does this mean for your current 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 5.45% to 5.95% with most lenders. The cost impact is for every $100,000 you owe, your monthly mortgage payment will increase by approximately $30.
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.
Fixed Rate Mortgage
Everything remains the same, with no change to your payment or mortgage.
What are your options?
If you are currently in an adjustable rate mortgage, you may be wondering what your options are. I’ve outlined a few:
- Stick with your initial strategy—make no change to your mortgage. Economists are predicting late 2023 or 2024 rate cuts.
- Consider converting to a fixed, keeping in mind the penalty implications. A 5-year fixed term may not be the best option for you, but perhaps a shorter 1-3 year fixed term may be better suited for your needs.
- Refinance to consolidate your debt and extend your amortization to reduce your payments, pay off high-interest debt and help provide cash relief.
- Change your adjustable rate to a variable rate mortgage with a static payment (assuming you can qualify). Keep in mind there is a trigger rate to ensure the principal is being paid.
What to consider before locking into a fixed rate mortgage?
If you lock into a fixed rate now, you would like to start paying the higher rate and increased payment right away. When inflation gets under control in the near term and rates come down to a point where the market rates are lower than the fixed rate you have, you will have to pay a big penalty to break your mortgage in order to take advantage of that shift.
What does this mean for your pre-approval?
If you have a pre-approval with a fixed rate, everything remains the same. There are no changes to your pre-approval or borrowing power.
If you have a pre-approval with a variable or adjustable rate, your borrowing power will change as the stress test increases. This may reduce your qualification by approximately 6-8% or $6,000 to $8,000 per $100,000.
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.
How does this effect 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 on the rise, this will have a direct impact on how much you can afford.
If you are in the market for a new home, have a mortgage renewal coming up in the next 4-6 months or are considering a refinance, we should talk about your options.
The next Bank of Canada announcement will take place on December 6th, 2022.
Tatum Neufeld, BComm
Mortgage Broker • Mortgage Tailors