How the Bank of Canada rate hike affects your mortgage

The Bank of Canada has increased its benchmark interest rate for the first time since 2010, a sign that the economy is improving enough to allow borrowing costs to rise from historic lows reached in the aftermath of the global financial crisis.

The overnight lending rate was raised to 0.75 per cent from 0.5 per cent, where it had been locked for two years as the country adjusted to the challenge that low oil prices posed for an already sluggish economy. Many economists expect the central bank to hike again this year.



Bank of Canada overnight lending rate

25-basis-

point rate

hike

THE GLOBE AND MAIL, SOURCE: BLOOMBERG

Bank of Canada overnight lending rate

25-basis-

point rate

hike

THE GLOBE AND MAIL, SOURCE: BLOOMBERG

Bank of Canada overnight lending rate

25-basis-

point rate

hike

THE GLOBE AND MAIL, SOURCE: BLOOMBERG

When the Bank of Canada changes its benchmark rate, the move ripples through to other interest rates, including those of mortgages. With that in mind, here is a guide to how the rate hike will affect homeowners and prospective buyers.

Homeowners with fixed-rate mortgages

There is no immediate impact on payments for existing mortgages. Only when the mortgage comes up for renewal would higher rates affect payments.

The interest rate on fixed-rate mortgages is influenced by the interest rates on bonds issued by the federal government, not the Bank of Canada’s overnight rate.

But if the central bank is confident enough about the economy to start pushing the overnight rate higher, expect interest rates in the bond market to rise as well. This explains how an increase in the overnight rate can indirectly affect fixed-rate mortgages.

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How will your mortgage payments change?

For those with a fixed-rate mortgage that will come up for renewal, we’ve created the following tool to see how your monthly payments could change.

First, figure out the mortgage amount remaining at the start of your next term, and the remaining amortization. (Talk to your mortgage lender to find out, or use a calculator like this one to get a rough idea.) If you wish to compare mortgage payments, check your mortgage statement to find your current monthly payment. Finally, test out some higher interest rates than you’re now paying.


*Notes: Calculation assumes biannual compounding. Results are for illustrative purposes only. Contact your mortgage broker for an official figure.

Homeowners with variable-rate mortgages

The interest cost on variable-rate mortgages is pegged to your lender’s prime rate, minus whatever discount you negotiated. The prime rate is in turn guided by the Bank of Canada’s benchmark overnight rate. Payments on most variable-rate mortgages will be adjusted higher in a matter of days or weeks to reflect an increase in the overnight and prime rates.

With some variable-rate mortgages, payments remain the same for the duration of the term. But there are adjustments going on in the background. As rates rise, more of your payment goes toward paying interest and less goes toward the principal. This will increase the amount of time it takes to pay off your mortgage unless you increase payments on renewal.

Borrowers tend to use the term “variable-rate mortgage” to describe all mortgages where rates can fluctuate during the term of the loan. However, lenders use the term “adjustable-rate mortgage” to describe mortgages where payments are reset according to changes in the lender’s prime rate. Variable-rate mortgages technically apply to those where the mix of principal and interest changes, but not the amount of the payment.

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One final note: Toronto-Dominion Bank is an example of a lender that has a “mortgage prime rate,” a unique in-house rate used for pricing variable-rate mortgages. TD’s mortgage prime has been higher than its conventional prime rate.

Prospective buyers

It could become tougher to qualify for home ownership.

Federal rules unveiled last fall require home buyers with a down payment of less than 20 per cent to “stress test” their ability to carry mortgage payments at whichever is greater: the negotiated rate in their mortgage contract or the Bank of Canada’s conventional five-year fixed posted rate.

The central bank’s rate is based on posted five-year fixed mortgage rates at Canada’s largest banks, and was most recently set at 4.64 per cent. That’s roughly two percentage points higher than many discount rates on the market.



When the Bank of Canada’s posted rate starts climbing, some home buyers will be “stress tested” at a higher rate. Joining the homeowner’s club will have a higher barrier of entry.

Even before the rate hike, the mortgage market was changing. In early July, Royal Bank of Canada raised rates by 0.2 of a percentage point for some of its fixed-rate mortgages as bond yields moved higher. Other major banks followed with their own rate increases.

Still thinking of getting into the market? Here’s a tool to show how your monthly mortgage payments would differ at various interest rates.

Just fill out the mortgage amount (the home’s purchase price minus your down payment) and the amortization period.

Monthly cost for a
25-year mortgage at various interest rates


*Note: Mortgage default insurance costs not included here. Calculation assumes biannual compounding.

For some context, mortgage broker David Larock says discounted five-year fixed rates for his clients ranged between 2.39 per cent and 2.59 per cent in the first half of 2017, while variable-rate mortgages were in the range of 2 to 2.25 per cent.

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Mortgage market breakdown

The latest survey data on mortgage borrowing suggest about eight in 10 borrowers who bought a home last year have a fixed-rate mortgage, 17 per cent have a variable rate and 3 per cent have a mortgage that combines a fixed rate and variable portion.



The outlook

Financial markets at mid-year expected the Bank of Canada to increase the overnight rate by a total 0.5 of a percentage point in 2017, which suggests one more increase of 0.25 of a point before year’s end. This would hypothetically take the prime rate at major lenders to 3.2 per cent from 2.7 per cent before the latest rate hike. Increases in the cost of fixed-rate mortgages will depend on how high rates for federal government bonds climb.

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