Over the past year-and-a-half, the Bank of Canada has raised interest rates rapidly to combat runaway inflation. That’s increased interest rates on mortgages and pushed up monthly expenses for many homeowners.
In July, the central bank raised its key interest rate by a quarter percentage point to 5 per cent and pushed out the timeline for getting price pressures under control
The impact on homeowners has varied, depending on the type of loan they signed up for: fixed or variable.
The calculator below helps you compare how different interest rates affect the cost of your mortgage.
How do higher interest rates affect fixed-rate mortgages?
A fixed-interest rate mortgage typically locks in payments for a set term of two to five years. This means people with fixed-term mortgages won’t see a change in the interest they pay on their mortgage until they renew their mortgage at the end of their current term.
If their mortgage term comes to an end while interest rates are higher than when they last signed a mortgage term, they could enter a new term at a potentially higher rate.
The interest rate on fixed-rate mortgages typically tracks government bond interest rates – mostly the rate on five-year bonds. That means changes in the bond market can impact fixed-rate mortgages, even without a change in the Bank of Canada’s overnight rate.
How do higher interest rates affect variable-rate mortgages?
Variable-rate mortgages are determined by the prime rate offered by lenders, which tracks the Bank of Canada’s overnight rate.
Some variable-rate mortgage payments adjust automatically when the prime rate increases. Other variable-rate mortgages have fixed payments, which means monthly expenses remain the same, but more of each payment goes towards interest rather than paying down the mortgage principal.
If rates rise enough, variable-rate mortgages with fixed payments can hit a threshold, known as the trigger rate, where monthly payments don’t even cover interest costs. At that point, the mortgage holder has to either increase their monthly payments or pay a lump sum to keep their payments steady.
Some lenders have also allowed people to extend their mortgage payback period to cushion the increase in monthly payments – although these mortgage-holders face a jump in monthly payments when their mortgage term resets, usually after five years.
Interest rates have a major impact on a borrower's monthly payments and the total cost of a mortgage. Here's how the Bank of Canada's recent interest rate hike decision might affect the cost of your mortgageFred Lum/The Globe and Mail
The mortgage principal is the amount you’re borrowing from the bank.
The amortization period is the total length of the loan, which is often but not always 25 years.
With files from Mike Rendell. Interactive from Carys Mills.
Mathilde Augustin