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Interest rates are headed up. What it means for variable and fixed mortgage rates

WATCH: During a news conference on Wednesday, Bank of Canada governor Tiff Macklem said as a result of ongoing supply chain disruptions and higher energy prices, the central bank now forecasts that annual inflation rates will continue their upward to nearly five per cent by the end of the year before coming back to its two per cent target by the end of 2022 – Oct 27, 2021

The Bank of Canada (BoC) said on Wednesday it’s keeping its trend-setting interest rate on hold for now, but borrowing costs for many Canadians are likely headed up.

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On Wednesday, Canada’s central bank said it is holding its key interest rate at 0.25 per cent, where it has been since March of 2020. But details of its policy announcement have analysts warning that interest rates are likely to climb higher sooner and faster than previously expected.

Read more: Bank of Canada signals rate hikes could come sooner than previously expected

Those revised forecasts have implications for current and prospective borrowers, including homebuyers and current mortgage holders.

“Barring another economic calamity, rates are going up. And they’re going up before the end of spring, possibly sooner,” says mortgage strategist Robert McLister.

Amid soaring inflation, the central bank hinted that the first interest rate hike could take place as soon as the April-to-June quarter of 2022. Analysts had previously expected rates to begin rising from record lows in the second half of 2022.

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Raising interest rates makes it more expensive to borrow and typically cools off economic activity and price increases, which helps tame inflation.

The sooner-than-expected rate increases analysts now expect sometime around the middle of next year would influence the cost of loans and credit with variable interest rates, such as variable-rate mortgages and most lines of credit.

But another type of interest with implications for mortgages has already begun to rise and could continue to do so after Wednesday’s BoC announcement. That’s the yield or interest rate on government of Canada bonds, which is a key benchmark Canadian lenders use to determine the interest on fixed mortgage rates.

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Read more: Canada’s housing market unlikely to cool as new home buyers opt for variable loans

On Wednesday, the BoC also said it is ending its quantitative easing program, which saw it buy up to $5 billion worth of government bonds weekly to help keep borrowing cheap and help the economy along during the earlier phases of the COVID-19 pandemic.

Now that the economic recovery is well on its way, the central bank is wrapping up its bond-buying spree. This will reduce the demand for government bonds and put upward pressure on yields.

If you’re wondering what this means for you, here are some possible scenarios.

If you're trying to decide between a fixed and variable mortgage rate

If you’ve been mortgage shopping recently, you’ve probably noticed variable mortgages rates are generally considerably lower than comparable fixed mortgage rates these days.

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A recent move by major Canadian banks to increase fixed mortgage rates on the back of surging bond yields is unlikely to slow the country’s red-hot housing market, as more than half of new borrowers take out variable-rate loans that are the cheapest they’ve ever been.

Read more: Why everything you want is out of stock or more expensive

The growing gap is the result of variable rates moving alongside the overnight rate, which hasn’t moved since the onset of the pandemic, and fixed rates, which have been following bond yields higher.

Based on the lowest nationally available rates for mortgages that don’t require mortgage insurance, the spread between variable and fixed rates currently sits at 0.95 percentage points, according to McLister.

That helps explain why homebuyers have been piling into variable rates recently.

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The market share of new variable-rate mortgages surged to 51 per cent in July — the highest level since the BoC began tracking the data in 2013 — from less than 10 per cent in early 2020, and mortgage brokers say this has continued to increase since then.

The share of Canadians who chose a variable rate when starting a mortgage quote through financial products comparison site RATESDOTCA has soared to nearly 32 per cent this month, compared with less than 13 per cent during the same month last year, according to statistics shared by the company.

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And the spread between variable and fixed mortgage rates “could widen in coming weeks as fixed rates march higher,” McLister says.

But if you’re considering signing up for a variable rate now, keep in mind the expectation that the interest rates that affect variable-rate loans will also start to climb sooner rather than later. While fixed rates stay the same for the duration of the loan term, variable rates fluctuate according to a benchmark set by the lender, which, in turn, usually moves up or down based on the movement of the BoC’s key rate. If rates rise, you’ll be saddled with higher interest costs.

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BMO chief economist Douglas Porter wrote in a note to clients that the bank now expects the BoC to begin increasing interest rates in mid-2022 and continue raising rates by a quarter of a percentage point every three months until late 2023, bringing its key interest rate “back in line with pre-pandemic levels two years hence.” The interest rate was sitting at 1.75 per cent before the pandemic set in, prompting a series of rate cuts.

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If you already have a variable mortgage rate, it’s a good idea to recalculate your mortgage payment using various rate-hike scenarios to ensure you are budgeting for the anticipated increases, according to James Laird, co-founder of financial product comparison site and president of CanWise Financial, a mortgage brokerage.

“Given the rate risk ahead, only a minority of borrowers should tempt fate with a variable,” McLister told Global News via email.

That group, he adds, includes financially secure borrowers who can comfortably handle the risk of rising rates, those who want the flexibility of breaking their mortgage with lower penalties (fixed-rate mortgages can have prohibitively high penalties), and those who don’t have long left to pay off their mortgage.

Still, it would take between four to six rate hikes by the BoC before today’s variable rate would be equal to today’s fixed rate, Laird notes.

And if you’re shopping for a home and want a fixed-rate mortgage, you should hurry to get a mortgage pre-approval right, which can lock in today’s fixed rate for 120 days, he adds.

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If your mortgage will soon be up for renewal

If you don’t have much more left on your mortgage term, you may want to consider refinancing now to lock in lower mortgage rates before they climb higher, Leah Zlatkin, a mortgage broker at rates comparison site, said via email.

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McLister agrees.

“The closer to two per cent that you can lock in, the better,” he says.

But, he adds, be careful about incurring pricey penalties for breaking your mortgage early.

“Just be sure you’re either with a fair-penalty lender or that there’s no chance you’ll break your mortgage before maturity, based on the term you select,” he says.

With files from Reuters


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