Mortgage rates are trending up in Canada, leaving many new home buyers and those looking to renew their mortgage worried. The newest shocker in the mortgage rates saga was TD Bank suddenly raising their posted rates on April 27, 2018, including their 5-year fixed rate to 5.59%. Although, posted mortgage rates are higher than the discounted rates most borrowers eventually obtain, the higher rates are nonetheless, an indication of where trends are heading in the longer term.
Following three hikes in the Bank of Canada’s (BoC) key interest rate since 2017, variable mortgage rates (and even fixed rates) have increased from their rock-bottom levels over the past 5 years. Government of Canada bond yields which influence fixed rates have not been left out of the upward trend.
Although the BoC decided to keep interest rates at 1.25% at their April 2018 announcement, the prediction is that their will be further hikes before the end of the year – maybe even as early as May 30th. This is due to increasing inflation, improving economy (in Canada and the U.S.), and increasing probability that the uncertainty regarding NAFTA will soon be a thing of the past.
Impact of Higher Mortgage Rates
The impact of higher mortgage rates is not lost on new home buyers. Combined with stricter mortgage rules and new “stress tests,” those in the market for a new home or who have a mortgage renewal coming up, now generally have to be in better financial condition to qualify for the best rates out there.
Under the new mortgage rules, both insured (mortgages with less than 20% in down payment) and uninsured mortgages must qualify at the greater of the Bank of Canada’s five-year benchmark rate (currently 5.14%) or the mortgage rate offered by their lender plus 2% points.
Therefore, as rates go up, the threshold for passing the “stress test” increases as well. It has been shown that the new mortgage rules/stress test lower home affordability by about 15%-20%.
The other aspect of increasing mortgage rates is the increase in monthly mortgage payments. This affects new home buyers and mortgage renewals alike. Increasing mortgage payments puts more pressure on Canadians who are already maxed out on debt, and who owe a record high of $1.71 debt for every $1 of disposable income.
Managing Higher Mortgage Rates – New Homeowners
New homeowners can prepare for any hikes in mortgage rates using the following strategies:
1. Shop Around and Compare Rates
Shopping for the best mortgage rates can save you thousands of dollars over the life of your mortgage. As you hopefully know already, the big banks rarely offer you the best available rates, and are also stricter when deciding who gets their most discounted rates.
Even small differences in mortgage rates matter. For example, on a $400,000 mortgage, a 0.50% rate difference will save/cost you over $1,000 per year.
Use online rate-comparison websites like Intellimortgage and Ratehub to compare the best mortgage rates available in your area and which match your specific needs. When comparing rates, remember to also compare the terms, including prepayment privileges and portability.
2. Bigger Down Payment
Putting down a bigger down payment lowers the mortgage loan you require and your monthly mortgage payments. A hefty down payment may mean saving and renting for longer, but that is not necessarily a bad thing.
Further reading: Rent vs. Buy a Home – Factors to Consider
3. Variable vs. Fixed Mortgage
Your choice between variable and fixed rate mortgage will depend on a host of factors including your peace of mind, financial position, penalties for breaking mortgage, mortgage amount and rates being offered.
Research done by Dr. Milevsky shows that in the long run, variable rates save homeowners thousands of dollars in interest payments over their entire mortgage term. However, long term is not always what’s prominent in the minds of new homeowners who have had to shell out significant sums of money for down payment and closing costs. They may be thinking about being able to survive the next few years without defaulting on their mortgage.
Questions to ask yourself as a new homeowner include:
- Can you afford a sudden rate hike of 0.25%, 0.50%, 0.75%, or more?
- What’s the difference (spread) between variable and fixed rate mortgages? Thin spreads make fixed mortgages more attractive.
- What are the penalties if you have to break your mortgage?
- Peace of mind vs. potential long-term savings with variable rates vs. risk of sudden rate hikes?
Further Reading: How to Decide Between a Variable or Fixed Rate Mortgage
4. Buy Less House
Choose a smaller home and by extension, a smaller mortgage. The mortgage amount a lender is willing to lend to you may actually be more than you can afford. Before buying, calculate your potential monthly payments and play with the numbers – if it increases by $50, $100, $200 or more per month, would you still be able to live comfortably?
Further Reading: How Much House Can I Afford?
Managing Higher Mortgage Rates – Current Homeowners
Homeowners whose mortgages are coming up for renewal also have to start thinking about mortgage rates and their options:
1. Break Your Mortgage
You can decide to break your current mortgage and renew at prevailing lower rates. Breaking your mortgage comes with a penalty – 3 months interest payments or more. For this strategy to make sense, your savings from the new mortgage rate must be worth it.
2. Lock-In A Fixed Rate Mortgage
If you currently have a variable mortgage and are unwilling to risk further hikes to rates, consider locking-in and switching to a fixed-rate mortgage. The downside to this strategy is that your rate/payment amount today will go up immediately. Additionally, if you need to break your mortgage in the future, your penalties will be higher.
3. Compare Rates at Renewal
When your mortgage renewal comes up, shop around for better rates. Chances are that you will find better offers from different lenders using a rate shopping site like Intellimortgage.
Note that you will need to pass a “stress-test” when you renew with a new lender.
4. Increase Payments
Another strategy to deal with rising mortgage rates is to shorten your amortization period by accelerating your mortgage payments and/or making lump-sum payments that cut into your principal.
Increasing your mortgage payments help you pay off your mortgage faster, lower your mortgage loan at renewal, and decrease your sensitivity to higher rates in general.
Further Reading: 4 Ways To Pay Off Your Mortgage Faster
5. Stick With Variable Rates
If your budget can handle the uncertainty that comes with variable rates, you can choose to stick with a variable mortgage. As mentioned earlier, in the long-term you will save more in interest payments when you use variable mortgage rates.
Additionally, homeowners with few years left on amortization and/or a small mortgage can better weather the risks of mortgage rates increasing. If rates go up, they have few years to bear the burden, or their mortgage payments are not so large as to throw a wrench in their standard of living.
News about rising interest and mortgage rates is not all doom and gloom. As interest rates continue to go up, your savings will eventually benefit from it as well – such as through high-interest savings accounts and GICs.
Of course, predicting future interest rates is mostly an exercise in futility. In the grand scheme of things, mortgage rates are still worlds away from the highs they attained in the 1980’s, and well below historical averages. So perhaps there’s no need to be alarmed – yet!
Further Reading: EQ Bank and High Interest Savings in Canada