The interest rate outlook is like a weather app that starts flashing red because of nasty conditions ahead.
In the past month, Bank of Canada officials have warned that the expected cycle of rate increases ahead could be bigger and come sooner than expected, while the chairman of the U.S. Federal Reserve has said “inflation is much too high” and talked of moving “expeditiously” to tame it. Unambiguous comments such as these from central bankers are unusual.
How much might rates go up? CIBC Economics said in a report published this week that the Bank of Canada’s benchmark overnight rate could rise as high as 2.25 per cent to 2.5 per cent from just 0.5 per cent today. The next rate hike could happen April 13 – don’t be surprised if the increase comes in at 0.5 of a percentage point, double the move made in March.
All those reasons people have on why interest rates won’t or can’t rise much? It’s time to park them. What we need to focus on now is how much extra weight borrowers will have to carry on mortgages, lines of credit and other floating rate debt.
With high levels of household indebtedness in Canada, there’s no question that the Bank of Canada has to be judicious in how much it raises rates. The bank also has to be careful not to tip the economy into recession with overly aggressive rate increases.
But controlling inflation is non-negotiable for central bankers, and inflation is running hot. The latest year-over-year increase in the cost of living was 5.7 per cent, which compares with the Bank of Canada’s target range of 1 per cent to 3 per cent.
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Sometimes overlooked in discussions about higher rates are people who have drawn down on their home equity lines of credit. The credit monitoring company Equifax Canada says the average HELOC balance at the end of last year was $52,000 and the average credit limit on new HELOCs was $189,000.
HELOC borrowing costs are pegged to a lender’s prime rate, which in turn tracks the overnight rate. Prime right now is 2.70 per cent – figure on prime getting close to 5 per cent if CIBC’s forecast for the overnight rate is correct.
The minimum required monthly payment on a HELOC is typically just the interest amount. To find out how much your minimum payments will cost you if rates rise by different amounts, try a credit line payment calculator offered online by your lender or a competitor.
One bank’s calculator shows a monthly interest-only payment of $138.67 on a balance of $52,000 at 3.2 per cent, which is prime plus a common markup of 0.5 of a point. At 5.5 per cent, the monthly minimum rises to $238.33.
It’s even more important to model your potentially higher mortgage costs using an online calculator. There are dozens of these calculators available – I like the one offered by Ratehub.ca because it easily lets you compare different monthly costs at various rates and amortizations. You can lengthen your amortization on renewal to get your payments down.
In a note to clients this week, BMO Capital Markets announced that “it’s straight up for mortgage rates.” BMO said five-year fixed rates have already pushed toward 3.5 per cent, while variable rates should rise past 3 per cent by midsummer.
The Ratehub calculator shows that if you have a mortgage balance of $500,000 at renewal time and a 20-year amortization, your monthly payments would be $2,893 with a fixed 3.5-per-cent rate, $3,021 at 4 per cent and $3,152 at 4.5 per cent. If you’re interested in a more extreme outlook, the monthly payment would be $3,286 at 5 per cent.
Discounted five-year fixed mortgage rates were in the 2.6-per-cent range back in mid-2017, so prepare for much higher borrowing costs if you have a five-year mortgage coming up for renewal this year and continue to like the fixed rate option.
After April 13, the next dates in 2022 where the Bank of Canada has an opportunity to increase rates are June 1, July 13, Sept. 7, Oct. 26 and Dec. 7. We are long past the point where these days pass by uneventfully. Borrowers, high inflation means the rate outlook is flashing red.
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Rob Carrick