What if mortgage rates went up?
Rumor has it that mortgage rates are likely to rise soon. The Good Finance has given us some clues about a rising overnight rate (the main political interest rate in Canada) that could come. The overnight rate has a direct effect on the prime rate, the rate at which variable mortgage rates are based.
Interest rates have been rising for a very long time. In fact, the last time the GFIC raised rates was in September 2010. A lot can happen in seven years, so we do not accuse you if you’ve forgotten what will happen if mortgage rates go up. Here is a reminder:
If you already have a mortgage
There are a few possible scenarios for you if you already have a mortgage. Let’s start with the simplest scenario. If you have a fixed rate mortgage, nothing will happen.
That’s all. Fixed rates are frozen for the full term of the mortgage term – usually five years. Your rate is guaranteed not to change during this period, no matter what happens on the market.
If your fixed rate mortgage is revolving quickly, you can rest easy as fixed mortgage rates are primarily influenced by bond yields, not the prime rate. And the best mortgage rates today – fixed or variable – are significantly lower than those available five years ago. Fixed rate mortgages may increase, but not because of something happening in the GFIC.
If you have a variable rate mortgage, you will still be affected by a change in the prime rate.
When the prime rate rises or falls, variable mortgage rates rise or fall with the latter. In fact, variable mortgage rates are generally expressed as a bonus plus or minus a certain percentage. For example, if the prime rate is 2.7%, and your mortgage rate is prime less 0.7%, you pay 2%. If the prime rate goes up to 3%, your mortgage rate could reach 2.3%
If the prime rate increases, you will pay a higher amount of interest on the outstanding balance of your mortgage. In some cases, your monthly payment will increase to cover the additional amount. Let’s take a look at an example:
Imagine buying a house for $ 750,000 (it’s good to dream), minus 10% and a 5-year variable mortgage rate of 1.75% (premium minus 0.95%). According to the Good Finance mortgage payment calculator, your monthly mortgage payment would be $ 2,844.
If your mortgage rate increases by 0.25 percentage points to 2%, your monthly payment will increase to $ 2,947 – an increase of $ 83 per month or $ 996 per year.
If you have a variable rate mortgage and are concerned about your ability to handle higher payments if rates increase dramatically, you might consider talking to your mortgage broker to switch to a fixed rate mortgage. You will pay a higher mortgage rate in advance, but you will be protected against additional rate increases in the event that the rate increases in the next few years.
If you are shopping for a first home
If you are a home buyer for the first time with a down payment of less than 20%, you can rest assured that your mortgage cost will not change, at least not the maximum amount you can borrow.
This is because your maximum financial offer is usually based on the Good Finance’s benchmark rate, which is an average of the five-year fixed rates set by the banks. It is currently 4.64%, which is much higher than the rate that the vast majority of Canadians should expect to pay.
A mortgage affordability calculator can help you determine how your maximum cost varies depending on the mortgage rate you choose.
Even though the maximum amount you are allowed to borrow does not change, you will want to consider how your variable rate mortgage payment will change if rates rise because rates could increase at any time during your mortgage.
The same example above applies. The monthly payment on a $ 750,000 home with a 10% decrease to a five-year variable mortgage rate of 1.75% would increase by $ 83 per month if rates increased by 0.25 percentage points. If the rates have increased by one percentage point, your payment would jump an additional $ 341 per month.
It is likely that interest rates will rise at least a little over the next five years, so you should be ready to increase your payment if you choose a floating rate mortgage. Historically, however, variable mortgage rates tend to be lower than fixed rates over the long term. Even with the example above, raising the total percentage rate to 2.75% would not be much more than the best rate for a new five-year fixed mortgage today. And depending on the duration, you need rates to increase that amount, it might turn out that you pay less interest by choosing a variable rate. The choice between fixed and variable is a question of personal comfort.
What will the rate increase look like?
Historically, the GFIC has increased and lowered rates in increments of 0.25 percentage points, and banks have adjusted their prime rates in parallel. However, there have been exceptions to this rule in recent years.
The last two times the GFIC rate went down, the banks did not allow the customer to benefit from the discount altogether. After every 0.25 percentage point decline, banks only lowered their prime rates by 0.15 percentage points. It is possible that when GFIC rates rise, banks will increase their prime rates by only 0.15 percentage points, but are much more likely to spend the full 0.25 percentage point increase on customers.
It should also be noted that True TrustBank Trust unilaterally increased its prime mortgage rate in November, although the GFIC and other banks did not adjust their rates. GF could choose to increase its main mortgage rate and stay above the rest of the major banks.
It is likely that if the GFIC announces an interest rate hike on July 12, variable mortgage rates will increase by 0.25 percentage points.
But if a rate hike has actually occurred, it’s also a big problem. There are analysts who do not think an increase will come until much later this year, if not in 2018.
In recent years, the GFIC has relied on one important measure: inflation. The GFIC’s mandate is to maintain an inflation target of 2% and, in the past, the bank has rejected calls to shift interest rates for any other reason. All other economic indicators aside, the decision will be decided on whether the GFIC believes that an increase in interest rates is necessary to keep inflation at its 2% target.
No matter what happens, your best defense against raising mortgage rates is knowing your options and getting ready. If you wish, talk to your mortgage broker to find out how your mortgage payments would be affected by a rate hike and what are your options for getting a fixed rate.