For the first time since 2018, the Bank of Canada (BoC) increased its target for the mortgage-influencing overnight rate earlier this year, kick-starting what’s predicted to be one of many increases to mortgage rates in 2022.
Experts have slightly different takes on where the overnight rate—which influences how banks will determine their own lending rates—will arrive by the end of 2022. Generally speaking, it’s expected the overnight rate will hit around 2.75% by the end of the year.
As rates rise, what does this mean for existing mortgage holders or those who are looking to get into the housing market?
Reza Sabour, a Vancouver-based senior mortgage advisor with Centum Financial Services LP, and Sung Lee, a RATESDOTCA expert and licensed mortgage agent, share their knowledge on rising interest rates and its effect on real estate.
Why and how do rates go up?
When we look at why mortgage interest rates are rising now, one of the biggest reasons is to tame inflation, which grew 6.8% annually in April, the highest rate since 1991.
Sabour explains that fixed and variable rates are determined by different factors. Fixed rates tend to mirror the Canadian bond market, and rise as the bond yield increases. Variable rates, on the other hand, are tied to the prime rate, which is based on the BoC’s overnight rate. The overnight lending rate reflects the overall state of the economy, which includes inflation, gross domestic product (GDP) growth and job numbers.
Any time the overnight rate changes, it impacts consumers with a product tied to the prime rate, such as variable rate mortgage products, Home Equity Lines of Credit (HELOCs), and other personalized credit, Lee explains.
As the economy starts to recover from the COVID-19 pandemic and we enter a quantitative tightening period, interest rates are now rising back to pre-pandemic levels.
“I try to explain to my clients that when rates are ultra-low—sub 10%—it’s obviously great as a borrower, but it’s not a very good sign of where the economy is overall when the government is forced to spend so much on stimulus to make things affordable,” said Sabour. “Now that we’re seeing the economy recovering quite rapidly and quite robustly, we’re obviously seeing rates going back to what they really should kind of be at.”
Interest rates for fixed mortgage holders started increasing in fall 2021. Now, with the BoC’s overnight rate increase in March and again in April, variable rate holders will notice their rates rise as well.
“For those individuals with a variable rate product with variable payments, they will see that increase,” said Lee. “Mind you, if you’re on a fixed-rate mortgage, you won’t notice anything, unless it comes to renewal time. That’s when you’re going to be hit with a higher rate than what you may have initially had.”
How do higher rates affect your ability to qualify for a mortgage?
When mortgage rates go up, it tends to affect a borrower’s budget and how much mortgage they can qualify for, especially when we consider the stress test and the types of mortgage rates out there.
“For people about to get into the market, the important thing to understand is, if they’re going to go for a fixed-rate mortgage, their stress test has now gone up,” said Sabour. “So now we have a situation where the stress test is different for a variable rate borrower versus a fixed rate borrower, and that really hasn’t happened before.”
In order to pass the stress test, borrowers for uninsured mortgages must meet the minimum qualifying rate of 5.25% or their mortgage contract rate plus 2%, whichever is greater.
As Sabour explains, mortgage rates on the fixed side are upwards of 4%. Once you add in the stress test’s additional 2%, this causes fixed rates to exceed the 5.25% stress test threshold. Therefore, if you’re going to qualify for a fixed-rate mortgage, you now have to qualify for more than 6%. By contrast, variable rate mortgages still fall below 5.25%.
“One benefit to a variable rate today is you can qualify at the 5.25% [rate] as opposed to potentially higher,” said Lee. “And so, that’s one option to get a larger mortgage size.”
As rates rise, existing borrowers might wonder how it affects their current payments. Sabour calculates for every 0.25% the prime rate goes up, your payment increases by about $12 on every $100,000 of your mortgage.
“If you calculate it that way, then on a $500,000 mortgage you’re still looking at just less than a $100 difference in your monthly payment,” said Sabour. “Yes, it’s a factor, but we’re not talking hundreds of dollars or a thousand-dollar difference in your mortgage payment.”
What should you do if you have a mortgage or are looking for one?
Whether you’re shopping for a mortgage for the first time or you’re exploring ways to renew or change your existing mortgage, you have options when it comes to rising rates.
If you’re not comfortable with the prospect of fluctuating rates and you’re in a variable rate mortgage already, you can opt into a fixed rate mortgage at any time with smaller term breakage penalties. However, switching from a fixed rate into a variable mortgage tends to come with much steeper penalties, so discuss your options with your mortgage representative.
The REALTOR.ca Payment Calculator and Affordability Calculator can help give you an idea of what your monthly mortgage payments could look like, as well as the size of the mortgage you may qualify for.
If you are a variable rate holder, Sabour explains you can talk with your lender to voluntarily increase your payments to a higher amount using prepayment privileges. By upping payments close to fixed rate levels or to a higher amount where variable rates will rise in the future, you can adjust to higher interest rates on your own terms and pay off your mortgage faster.
“That way you’re already paying the higher monthly payments, so you don’t have the sticker shock next time the prime rate goes up, but also the benefit of it is anything extra you’re paying through that payment is going directly to principal,” he said. “So, you’re actually making an extra payment within that payment and reducing your principal balance.”
As rates change frequently, Sabour and Lee stress it’s important to get pre-approved for a mortgage and lock in a rate. That way, when you’re searching for a home, you know exactly how much mortgage you can qualify for and know ahead of time what interest rate you can pay.
“I’d always recommend for anyone who is looking to get into the market, especially when we’re in a rising rate environment, to lock in a rate as soon as possible,” said Lee. “You can lock in a rate for as long as 90 to 120 days, and so it just provides peace of mind that, should rates skyrocket, you still have that rate locked in. The other thing about a pre-approval is it will let you know how much you can actually afford.”
If you’re looking for more insights on interest rates and how they can impact you, speak with an experienced REALTOR® for the most up-to-date information.
The information discussed in this article should not be taken as financial or legal advice. This article is for informational purposes only.
Michelle NcNally, Realtor.ca