What to Expect in a Rising Mortgage Rate Environment
Written by Penelope Graham
Friday, June 15th, 2018
Canadian borrowers are in for some sticker shock.
After years of deeply discounted interest rates, lenders are on a hiking spree: Improving economic conditions have prompted the Bank of Canada to increase its trend-setting Overnight Lending Rate multiple times since last July.
While this directly impacts how consumer lenders price their variable lending products – including floating-rate mortgages and lines of credit – the big banks are also increasing their fixed rates.
Toss in the newly-minted stress test, and Canadians are experiencing a rate environment that's heating at the fastest pace in a decade.
Why Are Rates Rising?
To understand why today's fixed and variable interest rates are on an uptick, we need to go back to why they were slashed so low in the first place: The Great Recession of 2008.
As the nation weathered a weaker job market and housing downturn, the Bank of Canada employed initiatives to prevent a credit crunch: keeping borrowing costs ultra-low kept the flow of funds liquid between financial institutions and encouraged consumers to continue spending. The central bank did this by maintaining its interest rate at 1 per cent between 2010 and 2015, and cut it further when oil prices dropped in January and July of the latter year.
Now it's a different economic reality. The job market, inflation, and core industries are looking up, allowing the Bank of Canada to "take off the training wheels". As a result, analysts expect at least one more rate increase to come before 2018 is done.
What Can Borrowers Do?
We hear advice saying that in uncertain economic times, it's safest to lock in with a fixed interest rate to ride out volatility in the market. But is that really the savviest route for today's borrowers?
Here's what to consider when choosing the right mortgage for you in a rising rate environment:
Know your risk tolerance:Fixed mortgage rates are a great option for risk-averse borrowers, since they guarantee your mortgage interest rate for the entirety of the term, regardless of what's happening in the market. For borrowers who want to ensure their shelter costs won't change month to month or don't have any wiggle room in their household budget, a fixed rate can be more suitable. The vast majority of home purchasers choose to go fixed, accounting for 72 percent of all new mortgages in 2017, according to a study from Mortgage Professionals Canada.
Avoid maxing out your budget:In hot real estate markets such as Vancouver or Toronto, it can be easy to get carried away and make a larger offer than you intended, especially in a multi-offer situation. However, maxing out the amount you're eligible to borrow can greatly reduce your financial flexibility, leaving you strapped if your mortgage rate increases. A great idea is to determine whether you could afford that Toronto condo or house with an extra 2 per cent padded into your monthly budget – before you bid.
Decide between high and low:Mortgage wisdom also dictates that you try to put as much down on your home as possible, in order to have the most equity right off the bat. Paying less than 20 percent down on a home also means default insurance is required and the premium will be rolled into your monthly payments.