The Bank of Canada has increased its benchmark interest rate for the second time this year, a sign that the economy is improving enough to allow borrowing costs to rise from historic lows reached in the aftermath of the global financial crisis.
The overnight lending rate was raised to 1 per cent from 0.75 per cent. The move followed a rate hike in July, the first since 2010. Until this summer, the benchmark rate had been locked at 0.5 per cent for two years as the country adjusted to the challenge that low oil prices posed for an already sluggish economy.
When the Bank of Canada changes its benchmark rate, the move ripples through to other interest rates, including those of mortgages. With that in mind, here is a guide to how the rate hike will affect homeowners and prospective buyers.
Homeowners with fixed-rate mortgages
There is no immediate impact on payments for existing mortgages. Only when the mortgage comes up for renewal would higher rates affect payments.
The interest rate on fixed-rate mortgages is influenced by the interest rates on bonds issued by the federal government, not the Bank of Canada's overnight rate.
But if the central bank is confident enough about the economy to start pushing the overnight rate higher, expect interest rates in the bond market to rise as well. This explains how an increase in the overnight rate can indirectly affect fixed-rate mortgages.
How will your mortgage payments change?
For those with a fixed-rate mortgage that will come up for renewal, we've created the following tool to see how your monthly payments could change.
First, figure out the mortgage amount remaining at the start of your next term, and the remaining amortization. (Talk to your mortgage lender to find out, or use a calculator like this one to get a rough idea.) If you wish to compare mortgage payments, check your mortgage statement to find your current monthly payment. Finally, test out some higher interest rates than you're now paying.
*Notes: Calculation assumes biannual compounding. Results are for illustrative purposes only. Contact your mortgage broker for an official figure.
Homeowners with variable-rate mortgages
The interest cost on variable-rate mortgages is pegged to your lender's prime rate, minus whatever discount you negotiated. The prime rate is in turn guided by the Bank of Canada's benchmark overnight rate. Payments on most variable-rate mortgages will be adjusted higher in a matter of days or weeks to reflect an increase in the overnight and prime rates.
Canada's largest banks raised their prime rates on Wednesday after the central bank's decision, matching the 25-basis-point move. Royal Bank of Canada was the first to respond, raising its prime rate by one-quarter of a percentage point to 3.2 per cent.
With some variable-rate mortgages, payments remain the same for the duration of the term. But there are adjustments going on in the background. As rates rise, more of your payment goes toward paying interest and less goes toward the principal. This will increase the amount of time it takes to pay off your mortgage unless you increase payments on renewal.
Borrowers tend to use the term "variable-rate mortgage" to describe all mortgages where rates can fluctuate during the term of the loan. However, lenders use the term "adjustable-rate mortgage" to describe mortgages where payments are reset according to changes in the lender's prime rate. Variable-rate mortgages technically apply to those where the mix of principal and interest changes, but not the amount of the payment.
One final note: Toronto-Dominion Bank is an example of a lender that has a "mortgage prime rate," a unique in-house rate used for pricing variable-rate mortgages. TD's mortgage prime has been higher than its conventional prime rate. After the central bank's hike in July, TD raised its mortgage prime rate by 0.25 of a percentage point to 3.1 per cent.
It could become tougher to qualify for home ownership.
Federal rules unveiled last fall require home buyers with a down payment of less than 20 per cent to "stress test" their ability to carry mortgage payments at whichever is greater: the negotiated rate in their mortgage contract or the Bank of Canada's conventional five-year fixed posted rate.
The central bank's rate is based on posted five-year fixed mortgage rates at Canada's largest banks, and was most recently set at 4.84 per cent, well above many discount rates on the market.
When the Bank of Canada's posted rate starts climbing, some home buyers will be "stress tested" at a higher rate. Joining the homeowner's club will have a higher barrier of entry.
Even before the July rate hike, the mortgage market was changing. Earlier that month, Royal Bank of Canada raised rates by 0.2 of a percentage point for some of its fixed-rate mortgages as bond yields moved higher. Other major banks followed with their own rate increases.
Still thinking of getting into the market? Here's a tool to show how your monthly mortgage payments would differ at various interest rates.
Just fill out the mortgage amount (the home's purchase price minus your down payment) and the amortization period.
*Note: Mortgage default insurance costs not included here. Calculation assumes biannual compounding.
For some context, mortgage broker David Larock says discounted five-year fixed rates for his clients ranged between 2.39 per cent and 2.59 per cent in the first half of 2017, while variable-rate mortgages were in the range of 2 to 2.25 per cent.
Mortgage market breakdown
The latest survey data on mortgage borrowing suggest about eight in 10 borrowers who bought a home last year have a fixed-rate mortgage, 17 per cent have a variable rate and 3 per cent have a mortgage that combines a fixed rate and variable portion.