Imagine you have just enough income to pay your bills. Then those bills jump 5 per cent, then another 5 per cent, then another 5 per cent, and so on, until you’re so underwater the stress makes you sick.
That’s how thousands of people carrying variable-rate mortgages feel right now.
And there’s more to worry about. The market suddenly expects a three-in-four chance that the Bank of Canada will boost the prime rate again by Sept. 6.
What about that hiking pause everyone’s been talking about?
McLister: This week’s lowest fixed and variable mortgage rates in Canada
Explainer: How Bank of Canada interest rate hikes affect variable rate mortgages
After 425 basis points of rate increases over the past year, many thought inflation was already under control.
Well, it turns out inflation isn’t dropping fast enough. Core CPI is suddenly accelerating on a three-month annualized basis, a time frame the central bank watches closely. On top of that, housing is rebounding vigorously, and the job market remains stubbornly tight – two key inflation risks.
To avoid a worst-case scenario where Canadians stop believing we’ll get back to 2 per cent inflation (the BoC’s greatest fear), it may feel forced to boost its policy rate for a ninth time – or so believe investors.
That’s quite a story change from March when the bond market was pricing in total cuts of more than a full percentage point this year. Albeit, the most recent rate hike outlook could be a bit hasty.
Calculator: Here's how rising interest rates affect the cost of your mortgage
The bond market tends to overweigh the latest data and overreacts to economic surprises. The interest rate derivatives, upon which these implied probabilities are based, are thinly traded and highly volatile. That’s why it pays not to read too much into them.
The likely outcome
Leading indicators confirm the North American economy is slowing. That means we’re likely near the top on rates, barring some out-of-the-blue inflationary event.
But this doesn’t mean the Bank of Canada won’t raise again, or that fixed mortgage rates won’t temporarily follow bond yields higher.
If we do get another quarter-percentage-point hike, four things will happen:
- Canada’s benchmark prime rate would jump to a suffocating 22-year high of 6.95 per cent.
- Adjustable-rate mortgages (ARMs) with 25-year remaining amortizations and a rate like prime minus 1 per cent, for example, would see their payments jump $15 a month per $100,000 of balance.
- Variable-rate mortgagors who have fixed payments and haven’t hit their trigger rate would see no payment strain. (A trigger rate is the mortgage rate where your payment is not covering all the interest due. Variable-rate borrowers can check their mortgage contract or call their lender to confirm what it is in their case.)
- Variable-rate mortgagors who have hit their trigger rate may or may not see their payments shoot up, depending on the lender’s trigger rate policy. (If you’re in this boat, call your lender to understand your payment risk. According to Desjardins Economics, approximately three-quarters of all variable-rate mortgages have hit their trigger rate already.)
Another rate hike at this point is no joke. Thanks to soaring interest costs, the share of new mortgagors with debt service ratios over 25 per cent – the level regulators consider vulnerable – surged 142 per cent last year.
Tens of thousands of Canadians are at their breaking point, which is one reason the BoC may hold off on another hike – despite the economic strength that is fuelling inflation.
To lower payments, advisers often tell borrowers to extend their amortizations. But generally, you can’t rely on that unless you’re sufficiently qualified and have at least 20 per cent equity, or you plead hardship, and your lender agrees to make an exception.
When things are tight and you can’t lower your payments, things get more complicated. Borrowers usually tap out their last remaining sources of credit or assets to cover their payments, and then resort to things like renting out a room, taking a second job or even selling.
If you’re overwhelmed by talk of another hike, two things are worth remembering.
First, if prime rate takes another leg up, anyone with a floating-rate mortgage needs a plan. And when it comes to family budgeting, preplanning is better than postplanning. If you simply can’t afford higher payments, know what cash, assets or credit you have to fall back on. Worst case, if you have no other outs and your lender can’t help, selling into this housing market’s current strength is better than missing a mortgage payment.
Second, another rate hike isn’t guaranteed. The central bank has deviated from market expectations multiple times since January, 2022. Moreover, rebounds in the consumer price index (like we saw this month) are common when the BoC is trying to get inflation down to 2 per cent. That’s why the bank doesn’t focus on one month’s numbers.
Next month’s data should be more to the BoC’s liking, so there’s a fair chance it will give existing rate hikes more time to work their magic. But, keep the faith regardless because two things are true when it comes to monetary policy. Economic downturns almost always take rates lower, and the Bank of Canada always wins the inflation war.
The clock ticks on rates
Bond yields drive fixed mortgage rates and those yields are up over 40 basis points in seven days. (A basis point is 1/100th of a percentage point.) Several lenders have already started boosting rates as a result. So if you’ve got a purchase, refinancing or renewal coming up in the next four months, and want a fixed rate, lock something down.
So far, the country’s lowest nationally available prime mortgage rate hasn’t changed. As this is being written, Nesto’s insured five-year fixed remains at 4.29 per cent.
Now, should people take a five-year fixed near the presumed top of a rate cycle? Generally not. But some still choose a five-fixed because the low contract rate lets them qualify for a bigger mortgage under the government’s stress test formula.
That, and perhaps a preoccupation with rate risk, are usually the only justifications for locking in a long term with monetary easing a possibility in 2024 – as tenuous as the inflation picture seems right now.
Rates are as of May 18, 2023, from providers that advertise rates online and lend in at least nine provinces. Insured rates apply to those buying with less than a 20 per cent down payment or those switching a pre-existing insured mortgage to a new lender. Uninsured rates apply to refinances and purchases over $1-million and may include applicable lender rate premiums. For providers whose rates vary by province, their highest rate is shown.
Robert McLister is an interest rate analyst, mortgage strategist and editor of MortgageLogic.news. You can follow him on Twitter at @RobMcLister.