As the Bank of Canada prepares to raise interest rates over the next year, many homeowners with variable rates those hikes would mean paying hundreds if not thousands of dollars more a year.JONATHAN HAYWARD/The Canadian Press
With the Bank of Canada readying to raise interest rates, the era of ultralow interest rates brought about by the pandemic will likely soon draw to a close.
But how, exactly, will an interest rate hike affect Canadians with debt? And perhaps more importantly, what will happen if a series of rate hikes unfold in the months ahead?
While the central bank’s trendsetting overnight rate broadly influences borrowing costs across the economy, it has a direct impact on variable-rate loans and credit products such as variable rate mortgages and lines of credit. When the overnight rate climbs, banks usually adjust their own prime rates, which are the benchmarks to which variable rates are pegged.
“The most affected will be variable-rate mortgage holders,” says James Laird, head of CanWise Financial, a mortgage brokerage. Once the Bank of Canada raises its rate, variable mortgage payments could go up as early as the next month.
Economists widely expect Bank of Canada Governor Tiff Macklem to make multiple rate hikes between now and the end of 2022, gradually lifting the overnight rate from its current low of 0.25 per cent by a quarter of a percentage point at a time.
For many homeowners with variable rates those hikes would mean paying hundreds if not thousands of dollars more a year.
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For example, take a five-year mortgage with a variable rate of 1.15 per cent, a down payment of 10 per cent and amortization of 25 years on a home priced at $720,000, which is roughly the current national average home price.
With a rate increase of a quarter of a percentage point, the monthly payment on such a mortgage would climb from $2,762 to $2,844, costing the homeowner $82 more a month and $984 more over 12 months, according to calculations from LowestRates.ca.
After another three rate increases of a quarter of a percentage point – in other words, after an increase of a full percentage point – that monthly variable-rate mortgage payment would climb to $3,101, an increase of $339 a month from the original payment, or $4,068 a year.
A year ago, 27 per cent of Canadians with a mortgage had opted for a variable rate or a combination of fixed and variable, according to Mortgage Professionals Canada. That share may have increased as spreads widened between fixed and variable rates in late 2021. RATESDOTCA says it saw a 147 per cent year-over-year increase in requests for variable-rate quotes in October.
Another group of borrowers who’d face rising costs are those who have outstanding balances on their home equity lines of credit. TransUnion, the credit bureau, estimates the average HELOC balance was just shy of $142,000 in the last quarter of 2021.
Someone with a HELOC balance of $142,000 at an interest rate of 2.7 per cent would see their monthly payments of principal and interest inch up from $650 to $668, a difference of $18 a month, or $216 a year, according to LowestRates.
Still, several factors might soften the short-term financial blow of rising rates even on borrowers with variable-rate debt. For one, not all variable-rate mortgage holders will feel the pinch of higher rates right away, says Leah Zlatkin, a mortgage broker at LowestRates. Many of her clients have variable-rate mortgages that keep payments steady – up to a certain threshold – even as the interest rate moves up. Instead, borrowers will see their amortization period extended in response to higher rates, meaning it will take longer to pay off the loan.
HELOCs, for their part, allow consumers to make interest-only payments, a feature that can provide some breathing room to financially stretched borrowers.
And Canada’s mortgage stress test rules will also help mute the impact of climbing rates, according to both Mr. Laird and Ms. Zlatkin. That’s because the test ensures borrowers’ finances are vetted against rates that are significantly higher than the actual market rates offered by lenders.
Still, even small, gradual rate hikes could dangerously stretch the balance sheets of Canadians who have seen their income decline and their financial situation deteriorate amid the pandemic, Ms. Zlatkin adds.
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Erica Alini