This week, Bank of Canada announced its target interest rate to 2.5 percent – the largest increase since 1988 . Just this past May, the Bank of Canada raised its target interest rate to 1.5 percent. This followed hikes to 0.5 percent in March and to 1 percent in April. The bank normally sets its target rates in January, March, April, May, July, September, October and December, and there has been talk of raising the target interest rate to 3 percent. Why is this happening, and how does it affect your mortgage payments?
Published on June 8, 2022. Updated July 14, 2022.
Why are interest rates going up?
In times of strong economic growth, more people want to borrow money to expand their businesses. Just like higher demand for anything else means price increases for those items, more people wanting to borrow money means that mortgage lenders need to pay investors a higher interest rate to get them to lend that money. So, interest rates generally go up when the economy is strong and go down when the economy is weak. This was also one of the reasons why interest rates dropped during the pandemic.
When inflation is high, Bank of Canada may raise the interest rate to slow things down a little. The 6.8 percent pace of inflation in April was the fastest rise from one year to another in over three decades.
Other factors that affect Bank of Canada’s interest rate policy include what is happening in other economies – especially the United States – as well as continuing supply-chain issues, the war in Ukraine and the lockdowns in China that make investors nervous.
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How do higher interest rates affect your mortgage?
While the Bank of Canada doesn’t set your mortgage rate, its interest-rate policy can affect the rates your mortgage lender will charge you. Exactly how much it will affect you depends on the type of mortgage you have.
If you have a fixed-rate mortgage, fluctuations in the Bank of Canada’s interest rate won’t affect you until it’s time to renegotiate your mortgage: The interest rate you pay remains the same for the entire mortgage period.
However, if you have a variable-rate mortgage, an increase in the interest rate means you’ll be paying more interest on your loan, which can mean that you either need to increase your mortgage payments if you want to stay on schedule or take longer to pay off your mortgage.
This doesn’t mean that a fixed-rate mortgage is necessarily better than a variable-rate mortgage. When interest rates drop, a variable-rate mortgage can save you money because you will now pay less interest: maybe even less than if you had a fixed-rate mortgage. So, while you may suffer in these times of high inflation, your variable-loan mortgage may work out cheaper in the long run. It boils down to whether you’re willing to take that gamble.
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What if you’ve been saving for your first home?
Higher interest rates mean your mortgage payments will be higher. If you’ve been saving for your first home, you may have to rethink your dream home and look for something more affordable, since passing the stress test to qualify for a mortgage becomes more difficult. Alternatively, you may want to take a step back and wait until you’ve saved more money, so you can put down a bigger deposit and have to borrow less in the form of a mortgage.
It’s depressing, we know, and it may look like you’ll never be able to afford anything other than a fixer upper. But there is a silver lining: Rising interest rates may mean the impossibly hot Canadian housing market will cool down somewhat. This will mean fewer bidding wars and less extreme price increases, which may make your dream home a possibility after all.
Should you start increasing your yearly payments?
We know: Everything is more expensive, so making higher mortgage payments is difficult as it is. Still, if you can find a way to revise your budget or if you land that pay raise, it’s a good idea to increase your yearly mortgage payments. The reason is simple: The more debt you have, the more you’ll eventually pay in interest. The sooner you can lower the amount you still owe on your mortgage, the less interest you’ll end up paying.
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