What you need to know about mortgages if interest rates rise
By now you may have heard it: The Bank of Canada (BoC) may raise its trend-setting interest rate on July 12, the next date when it is set to review its interest rate policy.
That, at least, is what a growing number of economists is forecasting. Some analysts still believe the hike will happen a little later this year, possibly in September or October. But whether it’s next week or in the next few months, the overwhelming consensus is that the BoC will lift rates before the end of the year.
What does this mean for Canadians who have a mortgage or are hoping to get one soon?
Here’s a rundown of different scenarios:
If you have a variable-rate mortgage
Some 30 per cent of Canadians have a mortgage with a so-called variable-rate, which moves up or down along with the general level of interest rates in the economy. If the BoC raises rates, homeowners with variable-rate mortgages will see their monthly mortgage payments go up.
- How much more will you be paying? Economists expect the BoC to hike rates slowly, by increments of 0.25 of a percentage point. Let’s look at the example of a homeowner with a home priced at $750,000, a minimum down payment of 10 per cent, and a 5-year variable-rate mortgage with an interest rate of 1.75 per cent and 25-year amortization. The total monthly mortgage payment for this homeowner right now would be $2,864, according to the mortgage payment calculator at RateHub, a rates comparison site. With an increase of a quarter of a percentage point that monthly payment would go up to $2,947, or $83 more per month. Now let’s look at what might happen between now and the end of next year. RBC expects the BoC’s key interest rate to climb by a full percentage point (from 0.5 per cent to 1.5 per cent) by the end of 2018. Under that scenario, the monthly payments in our example would rise to $3,205, or $341 more per month.
- Does it make sense to lock in to a fixed-rate mortgage? Variable-rate mortgages come with the option of switching to a fixed rate during the term of the loan. Doing so might buy you peace of mind if the thought of rising interest rates keeps you up at night. But locking in has a cost. “Conversion rates are never as aggressively priced as those offered to borrowers who have yet to walk through the lender’s front door,” David Larock, a Toronto-based independent mortgage broker recently wrote in a post weighing the pros and cons of fixed- and variable-rate mortgages. Some lenders also demand that borrowers locking in sign up for a five-year term, no matter what the remaining term of their current loan is. If you do the math, you might find that you’re better off sticking with your variable rate. When an interest rate increase appears close, “everybody panics and rushes to lock in, but those knee-jerk reactions aren’t generally prescient over time,” Larock told Global News. Though it’s impossible to know how interest rates will move, Larock doesn’t believe they’ll go very far in the short term. John Pasalis, president of Toronto-based brokerage Realosophy, agrees: “No one really expects rates to skyrocket.”
- What about breaking your variable-rate mortgage and getting a better fixed-rate loan with another lender? Unlike fixed-rate mortgages, variable-rate mortgages typically carry a relatively low penalty for breaking the loans: Only three months’ worth of interest, according to Larock. Variable-rate borrowers worried about interest rates could quit their lender and seek out a fixed-rate mortgage with a lower rate than the conversion rate in their current loan. Switching mortgages, though, involves a lot of paperwork and legal fees, noted Larock. And homeowners ditching their variable-rate loan would likely only be eligible for rates offered to homeowners refinancing their mortgage, which are generally higher than the rates offered to homebuyers, Larock added. “The competition for the [mortgage] refinance business isn’t as strong,” he told Global News.
WATCH: The Bank of Canada could raise interest rates as early as mid-July. Who would higher interest rates benefit and who would they hurt?
If you have a fixed-rate mortgage
Over 65 per cent of Canadians have fixed-rate mortgages, which, as the name implies, remain fixed through the term of the loan. Here’s what these homeowners need to know:
- An interest rate hike affects fixed-rate mortgages, too. Fixed-rate mortgages tend to follow bond yields, the amount of return investors realize on bonds. But investors’ expectations about what the BoC will do with its key rate affect bond yields. Therefore, indirectly, an interest rate hike has implications for fixed-rate mortgages, too. “The mere mention of a rate hike had an effect on bond yields, already resulting in an increase in the popular 5-year fixed rate mortgages over the last month,” James Laird, co-founder RateHub.ca and president of CanWise Financial mortgage brokerage, said in a statement. This means that most Canadians with a fixed-rate mortgage will likely have to pay a higher interest rate when they refinance their loan.
- Canadians who are about to refinance a five-year fixed-term mortgage may have a pleasant surprise. Although rates on fixed-rate mortgages are headed up, they are still significantly lower than they were five years ago. Therefore, Canadians with a five-year mortgage coming up for renewal in the next little while may find that their new rate is lower.
If you’re about to get a new mortgage
If you’re house-hunting right now, keep in mind the following:
- Think about getting pre-approved for a five-year mortgage. “Anyone currently shopping for a home should get a pre-approval, which guarantees today’s fixed rates for 120 days,” said Laird.
- The stress-test for homebuyers will likely remain the same. Homebuyers applying for a variety of variable- and fixed-rate mortgages are stress-tested against the BoC’s qualifying rate of 4.64 per cent, which is much higher than the mortgage rates most Canadians pay. The BoC’s posted rate is the mode (i.e. the most common occurring number) of the five-year fixed mortgage rates advertised by Canada’s six largest banks. But those advertised rates bear “very little correlation” with the discounted mortgage rates banks are actually offering customers, said Larock. Banks generally use their advertised rates to calculate penalties for borrowers who break their mortgage, he added. Even if banks are hiking the rate of their fixed-rate mortgages, they’re unlikely to adjust their advertised rates, Larock told Global News. As a result, the stress-test benchmark for homebuyers is likely to remain the same.
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