Essential Knowledge Series
The bank of Canada raised their overnight lending rate this past Tuesday on March 2, 2022. In other words, the bank of Canada raised the rate they lend money to 0.50% from 0.25%. What's important to you as the consumer is how this affects the prime rate for your lender.
If you hold a variable rate loan of any kind, this means your rate will increase by 0.25%. For example, if you had a $500,000 mortgage, amortized over 25 years and you had a prime minus 0.90% adjustment with a 5 year variable term, you would have had a 1.55% interest rate on Monday.
As of Tuesday, your rate would increase by the 0.25% mentioned earlier up to 1.80%. Is this bad? That all depends on your mortgage amount and current budget. Let's go back to the $500,000 mortgage I previously mentioned.
Your mortgage payment would be $2,010 per month at the 1.55%. Increase this to 1.80% and your payment goes up to $2,069 per month. Not a huge increase, but nevertheless, still an increase of $59.
Let's look at another example. If you had a mortgage for $750,000, amortized over 25 years at 1.55% (prime minus 0.90%), your payment would be $3,015 per month. With the same interest rate increase, your payment would increase to $3,104 per month - an increase of $89 per month.
Again, in the grand scheme of things, this isn't a huge increase. However, if your budget is already tight, this, along with rising living expenses (gas prices), can create some unwanted stress.
What's important when thinking about obtaining a mortgage, or if you currently hold a mortgage, is where the variable rates are now and where you think they are heading - compared to the fixed rates. In other words, if you could get a variable rate mortgage today at prime minus 0.70% (2.70%-0.70% = 2.00%), and the equivalent 5 year rate is a 3.29%, how many increases would have to happen before you reach that same fixed rate?
In this case, you would have to see the Bank of Canada (BoC) raise their rates by another 1.29% over the course of your term. Is this possible? Yes. Is this probable? The short answer is no. Generally speaking, the BoC will only raise rates on a 0.25% basis.
Here is a chart showing how prime has changed over the past 12 years. As you can see, from July 2017 until October 2018, the BoC raised rates 5 times, 0.25% every time. So does this mean this is going to happen again? It's too early to tell. One thing is for sure - if the BoC raises rates too quickly, and too much, the average homeowner won't be the only ones in trouble. The Canadian government also borrows money from the BoC and this would cause some serious macroeconomic issues for Canada, but that's for another post.
Going back to the 1.29% the rate would have to increase, you can see that if we look back to recent history, your variable rate mortgage would have the advantage because even though your rate increased, you were paying less every month while the rate slowly went up. Compare this to the fixed rate and you would have been paying the 3.29% all along. (If you're curious to see if a variable makes sense for you, we have a calculator that figures out these exact hypotheticals).
Either way, with inflation being this high, the BoC has some big decisions on its hands. In this case, I have a feeling we might not be able to use the old saying, "history repeats itself". After all, who could have foreseen the past two years?
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