Plus: The trajectory of interest rates throughout the year to date
The Bank of Canada has been hiking interest rates throughout the year, meaning some Canadians will have to spend much more money on their mortgage bill each month. But what is driving these rate increases? And how is it impacting Canadians? Here is what you need to know about mortgage rates in Canada.
What makes mortgage rates go up?
While the financial health of borrowers impacts their interest rate after being offered a loan, government monetary policy and other economic factors impact the entire mortgage rate ecosystem. However, the basic rules of supply and demand are reflected in the numerous factors at play.
A major contributor to rising mortgage rates is inflation, which is hotter than expected. In particular, the cost of groceries is continuing to increase at the fastest pace in decades and is expected to spur further interest rate hikes in the coming months. Canada’s inflation rate remained high in September, even through it dropped from 7% in August to 6.9% last month, according to Statistics Canada’s latest consumer price index (CPI) report.
Gas prices fell by 7.4% from August to September while groceries increased at the fastest rate since 1981. Compared to a year ago, the cost of groceries is up 11.4%. It is also the 10th straight month that grocery costs have outpaced the overall inflation rate.
These are critical factors that significantly impact mortgage rates since inflation erodes buying power over time. Typically, lenders must maintain interest rates at least enough to overcome the erosion of buying power. In other words, lenders must make sure their interest returns signify a real net profit.
What is the impact of rising mortgage rates on home buyers?
After property prices skyrocketed across Canada throughout the COVID-19 pandemic, home buyers are now seeing prices fall in many cities across the country as borrowing costs increase. The Bank of Canada (BoC) raised its policy interest rate by 1% (or 100 basis points) in July, which was the fourth consecutive interest rate hike since March. Another rate increase was announced in September.
The BoC’s policy interest rate affects the rate that Canadian banks lend money to home buyers at, meaning that Canadians shopping for homes will not see the low mortgage interest rates they have seen over the last few years. It also means that while house prices are decreasing, homebuyers may have more difficulty qualifying for higher mortgage amounts.
One key decision homebuyers will have to make is whether to go with a fixed or variable interest rate mortgage. When interest rates are rising, some buyers may opt for fixed rate mortgages because they will know precisely how much their mortgage payment will be for the entire mortgage term, especially buyers concerned about further interest rate hikes.
With a variable interest rate mortgage, on the other hand, buyers are subject to potential fluctuations throughout the mortgage term. In either scenario, it is important to speak with a mortgage broker to find out what makes the most sense for you and your financial situation.
What should homebuyers do during this time?
In anticipation of possible increases, assessment criteria for mortgages have been based on a rate higher than the one offered. That means that the buyer’s ability to repay the mortgage has already been verified, even within the context of a higher interest rate. If a buyer’s financial situation has changed, it would be time to speak to an advisor to help them recalculate.
If the buyer has a fixed-rate mortgage, the payment stays the same until it is renewed. For variable-rate mortgages, on the other hand, the payment amount is also fixed. More interest means the buyer will pay less principal on the mortgage with every payment, meaning that at the end of the term, the balance could be more than initially thought.
It's also possible to talk to your clients about buying mortgage points, this could be helpful if they have some savings and they do the math on how much they will save over the long term.
In other words, it is important to understand that your financial situation was accounted for even within the context of these rate increases, and not to panic.
What is the interest rate forecast for 2022?
At the beginning of 2022, the Bank of Canada’s key interest rate was at a record low of 0.25% before increasing to 0.5% in March, and then again to 1% in April, 1.5% in June, and 2.5% in July. It increased again to 3.25% in September. The forecast for the remainder of 2022 is complex and is at the mercy of central banks’ policies and the financial markets. Geopolitical tensions such as the war in Ukraine and other external events also have an impact on those calculations. One thing that is certain in the near-term is that the BoC will continue raising key interest rates throughout the rest of this fall.