Real Estate

Bank of Canada raises interest rates for sixth consecutive time. Here’s what it means for cottage mortgages

Tiff Macklem delivers news about the Bank of Canada raising interest rates in a press conference on October 26, 2022 Photo via Bank of Canada/YouTube

The Bank of Canada is once again raising interest rates. On Wednesday, the bank bumped its policy interest rate up 50 basis points to 3.75 per cent. This is the sixth consecutive hike since March, and the highest the rate has been since 2008. Canada’s major banks, including TD, RBC, and CIBC, are expected to follow suit, raising their prime lending rates by the same amount.

The increase will make it more expensive for Canadians to borrow money and pay off loans, including lines of credit, student loans, credit card payments, and mortgages.

Why are interest rates going up?

Inflation remains well above the bank’s target goal of two per cent. By raising interest rates, the bank is attempting to discourage Canadians from overspending, in turn lowering the inflation rate.

In June, inflation hit a 39-year high of 8.1 per cent. Since then, the rate has eased to 6.9 per cent, largely due to a fall in gas prices. But the bank’s governor, Tiff Macklem, says this isn’t enough.

“We have yet to see a generalized decline in price pressures,” he said, during a press conference. “The economy is still in excess demand. It’s overheated. Households and businesses want to buy more goods and services than the economy can produce, and this is driving prices up.”

Countries around the world are seeing similar inflation rates as they emerge from the COVID-19 pandemic. The global supply chain continues to be disrupted by COVID lockdowns in China and energy shortages caused by Russia’s attack on Ukraine. As a result, supply is diminished, which causes prices to rice.

“As economies slow and supply disruptions ease, global inflation is expected to come down,” the bank said in a statement.

How long will the rate hikes last?

The bank predicts that inflation will return to its target of two per cent by the end of 2024. But to make that happen, Macklem said that interest rates will need to increase further. “How much further will depend on how monetary policy is working to slow demand, how supply chains are resolving, and how inflation and inflation expectations are responding to this tightening cycle,” he said.

Macklem pointed out that the higher interest rates are already working. Demand has slowed in interest rate-sensitive parts of the economy, including housing and other big-ticket items, such as vehicles. He added that if current trends continue, future interest rate hikes may be smaller.

“We are getting closer, but we’re not there yet,” Macklem said.

What does this mean for mortgages?

Higher interest rates will put an added strain on mortgage holders, especially those paying off both a home and cottage mortgage.

“If you purchased [a fixed-rate mortgage] during the first part of COVID, or even just before COVID, you would have seen record-low interest rates,” said Robin Dillane, a mortgage broker with Haliburton Mortgage Services. “That’s fine until the mortgage comes due. Then it’s going to be really hard.”

Current fixed-rate mortgage holders could see their interest rates jump by two to three per cent when it’s time to renew, adding several hundred dollars to their monthly payments.

“During COVID, we were down to about 1.9 per cent on some fixed rates. Now you’re seeing percentages in the fives. And if they continue to raise, you’d probably see closer to the sixes,” Dillane said. “It’s going to make it hard for the average person.”

As for variable-rate mortgages holders, their monthly payments are already on the rise. Variable-rate payments fluctuate based on the bank’s interest rates. As rates continue to go up, there’s concern that variable-rate mortgage holders will pass their trigger rates. This is when interest rates have gone up so much that an individual’s monthly payments are only covering the interest and aren’t paying down any of the principal loan.

In August, RBC revealed that 80,000 of its customers were about to pass their trigger rates, adding an extra $200 to customers’ monthly payments.“Everybody’s is different, and you should be checking in your contracts for those trigger rates,” Dillane said.

Higher interest rates will also make it more difficult for people to pass the stress test to secure a mortgage. The stress test determines whether an individual will be able to pay their mortgage if interest rates increase. To qualify, they must show that they can pay the benchmark rate of 5.25 per cent or their lender’s rate plus two per cent, whichever’s higher. Since interest rates are up, it’s likely the lender’s rate will be higher. If the individual can’t afford mortgage payments at this rate, the bank won’t loan the money.

Dillane pointed out that there is a way around this. If the individual opts for a variable-rate mortgage, some banks will offer the loan at below their prime lending rate, making it easier to qualify. The only problem is that a variable-rate mortgage is much riskier as you can’t predict the monthly payments.

How do you prepare for interest rate hikes?

Fixed-rate mortgage holders worried about rising interest rates should calculate how much their monthly payments will go up at the time of renewal, based on current interest rates, Dillane said, then increase their monthly payments to that amount.

“The extra money that you’re putting on your mortgage, because you’re contracted at a low rate, goes directly off the principal, so when that mortgage is renewed, you actually have a lower principal amount,” she said. “If the rates are higher, you’re kind of buffering to still be able to afford that mortgage.”

By choosing to increase payments, it not only helps pay down the principal faster, but also gives the mortgage holder a sense of control over their budget, rather than having the increase forced on them, Dillane said.

While variable-rate mortgage holders can’t operate on the same predictability, they can adjust their payments. Work in round numbers, Dillane suggested. For instance, if the monthly payment is $1,125, round it up to $1,200. “You just built in an extra $75,” she said, “and you won’t even notice it over the course of the mortgage.”

Paying more up front may sound daunting, but according to Dillane: “It’ll reduce the amount of stress that you’re going to have when you have no option but to increase your payments.”

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