On Wednesday June 1, 2022, The bank of Canada officially announced the increase to the overnight lending rate by 0.5%. This announcement was the world’s worst kept secret for the last few weeks as Canada’s banks were anticipating this and will be increasing their prime rates in the coming weeks. This will impact Canadian home owners with home equity lines of credit, and adjustable rate / variable rate mortgages.
It is important to note that these changes impact variable and adjustable rate mortgages directly and immediately. These increases DO NOT impact fixed rate mortgage directly and immediately. It is important to note however that even if you are currently in a fixed rate mortgage, you should still be paying attention, especially if this is your first mortgage and you have obtained it in the last 2 or so years. That is because if you were to renew today, your rate would pretty much double. While it is important to mention this: Do not let anyone pressure you into a decision based on these rate changes. Do not ignore what is happening either. Most people end up having to make a change to their mortgage in some capacity at around the 36 month (3 year) mark. It’s important to plan ahead, so if you have some questions or anything, feel free to reach out and book a 15 minute consultation.
What does this increase in interest rate cost you per month?
This 0.5% increase will lead to an increase in interest costs equivalent to about $28.00 per month for every $100,000 borrowed on variable and adjustable-rate mortgages. Those with adjustable-rate mortgages will see their payments actually increase to align and keep up with the amortization schedule whereas those with variable-rate mortgages will not see an increase in payments. Rather, the distribution of the payment towards interest will increase, while the portion towards principal will decrease.
Will this increase impact some Canadian’s ability to buy or refinance?
This is the question that has been garnering a lot of attention, especially of late with the level of rate increases we have seen. The concern is that these rate rises can trigger an increase to the stress test, the rate that is used to qualify. An increase to the qualifying rate means that borrowers will qualify for less of a mortgage to purchase or at refinance. So far, we have not seen a change to the benchmark qualifying rate. It remains at 5.25% at the time of this writing. The rules, as they were laid out by the government in 2016, state that to qualify the mortgage, you must use the greater of the contract rate + 2%, or the qualifying rate. If you were to take a fixed rate today, at say 4.5%, this is the contract rate, adding the 2% to that would take the qualifying rate to 6.25%. The bench mark rate is 5.25%, so in this case we would have to use the 6.25% to qualify you for a fixed rate. For a variable rate mortgage, the same rules apply, but if your discount is prime – 0.5% for example, and prime is now at 3.7%, your rate is 3.2%, +2% this takes you to 5.2%, the benchmark rate is 5.25% which is greater than the contract rate + 2%. So, the way that the rules are laid out, you qualify for a higher mortgage if you take a variable rate as opposed to a fixed rate.
What is going on with fixed rates currently?
The best insight into where fixed rates are headed, short of a crystal ball of course, is the Bond yields. For years, bond yields have provided great information as to what we can expect to see with fixed rates, and measure their behaviour. Over the last 2 or so weeks we have seen bond yields drop some, but. over the last quarter we have seen bond yields rise from around 1.5% to 2.7%. This has resulted in a significant increase to the average five year fixed rate. We are currently in the mid 4% to high 4% range for 5 year fixed terms with most lenders.
Should you choose a fixed or variable mortgage?
Even if we factor in this increase of 0.5% a borrower who chooses a variable rate mortgage would need to see between 7 and 10 increases in increments of 0.25% over the next two to five years to hit a point where they would be at break even with current fixed rate mortgages. In other words, you would still be saving if you went with the variable rate, as opposed to the fixed rate, and you would have some insulation as well, so by going with the fixed rate today, you would be automatically increasing up to about 7 to 10 rate hikes of 0.25% yourself, in one go.
It is our opinion that variable rate is still the more flexible option for borrowers and likely the better choice.
Now it is not always about the math, and if it is impacting your peace of mind, you cannot put a dollar amount on that. No amount of savings can account for loss of sleep. If you have some concerns or some questions, please feel free, to reach out.
Will this rate increase impact the housing market?
Historically, we tend to see the impact of rate increases on the real estate market typically about 60 to 90 days after the fact and we can expect to see the cumulative affect of rising rates over the coming months. It has been a heavy dose of increases for the last quarter, which we will see play out in the second half of 2022.
What should Real Estate Investors and Home Buyers be aware of?
Immediate and growing concerns seem to be on Presale and Commercial. For presales, we started to see some clauses being put into contracts about 60 days ago, that allow the developer to increase the prices before closing should their costs to build increase. These clauses are beginning to appear in more and more presale contracts. We have spoken to a law firm that specializes in real estate transactions as this is very new and there has not been any rulings or judgements on them and they are of the opinion that this clause can be enforced – since it is in the contract. So it has now never been more important to have your contracts reviewed by a lawyer to understand it and make sure it does not have this type of clause.
With respect to Commercial Properties the growing concern is the impact of the rising rate environment on renewals. If a commercial real estate building’s net operating income does not increase in equal proportion to rising rates the concern is that lenders will refuse to renew or they may require owners to pay down significant amounts of debt prior to renewal.
The concern for rising rates at renewal are also prevalent on the Residential side of things as well/ Lenders may not refuse to offer a renewal, but the payment shock at renewal may be significant. And for those in Variable Rates, with Static mortgage payments. While your payments remained steady – with the increase in the interest, it could take you into a negative amortization situation, in which case the lender may also ask for a lump sum payment, to get you back on track.
Please feel free to reach out with any questions or concerns. We are here to help.