Over the last decade, Canadians have seen some of the lowest interest rates in history. This has been a huge opportunity for first-time homebuyers since low rates make the cost of borrowing cheaper and buying a home easier (in some markets). There's just one issue: with interest rates so low, they can only go up. When that happens, your monthly mortgage payments may increase. This has made buyers anxious, since rising interest rates may affect how much they can afford.
In addition, homeowners who have variable rate mortgages may also worry about how a potential rate hike will affect their mortgage payments. While rising interest rates are something to be aware of, there are ways you can navigate this within your mortgage. Let’s walk you through what you need to be aware of.
How do Bank of Canada interest rates affect mortgage rates?
First you need to understand how mortgage rates are set. Most homebuyers need a loan. This is known as a mortgage: it's an agreement between you and the lender that sets out the terms, including the interest rate.
When applying for a mortgage, the interest rate you're offered depends on a few factors, such as:
- the overnight rate set by the Bank of Canada (BoC), which is the rate at which banks borrow from and lend to each other in the overnight market
- your credit rating
- your decision between a variable or fixed rate mortgage
- the term or length of the mortgage
In most cases, the overnight rate set by the BoC has the biggest effect on variable rate mortgages. When the BoC increases the overnight rate, variable rate mortgages become more expensive. Conversely when the BoC decreases the rate, carrying a variable rate mortgage becomes less expensive.
Your credit rating is another important consideration when banks determine what mortgage rate they can offer. If you have an excellent credit score, you'll likely be approved for better rates than if you have a lower credit score.
Your credit score is a number between 300 and 900. If your credit score falls between 700 and 900, it is typically considered good. Once your credit score drops below 700, you may find it difficult to get a good rate or even be approved for a loan.
If you want to improve your credit score, you can:
- pay off debt
- always make payments on time
- make more than the minimum payments on your credit cards
- keep your account balances below 35% of your available credit
What is the current Bank of Canada rate and how often can it change?
Since the Bank of Canada can change interest rates eight times a year, it's best to check its Policy Interest Rate page for the most up-to-date information on the current rate.
When are Bank of Canada interest rate announcements in 2022?
The Bank of Canada makes announcements eight times per year – usually on Wednesdays -- about its target overnight rate. The 2022 announcement schedule:
- Wednesday, January 26
- Wednesday, March 2
- Wednesday, April 13
- Wednesday, June 1
- Wednesday, July 13
- Wednesday, September 7
- Wednesday, October 26
- Wednesday, December 7
How do interest rate hikes affect inflation?
When interest rates are higher, they encourage people to save. Since it is a good time for people to save, less borrowing and spending tends to happen. That means companies may increase their prices at a slower pace or even lower prices to get people to spend again. This reduces inflation, since the costs of goods aren’t going up in price as quickly as they would otherwise.
Lower interest rates work in the opposite way. Not only does it cost less to borrow money when interest rates are low, but you also earn less from keeping your money in savings — which means you may end up spending more money. This increase in consumer spending could cause prices to rise as consumers are willing to pay more.
The Bank of Canada actively uses interest rate increases and decreases to control inflation. The BoC tries to keep inflation at 2% a year, as most of the population can handle that level of year-over-year change.
What does a potential rate hike mean for your mortgage?
A potential rate hike will affect you in different ways depending on whether you're a first-time homebuyer or you already own your home.
For first-time homebuyers, any increase in interest rates will reduce how much home you can afford. That's because your carrying costs (your costs for owning a property) will increase.
For example, let's say you need a $500,000 mortgage and the interest rate is 3%. Your monthly payment would be $2,366 on a 25-year amortization. However, if the interest rate was 4%, your monthly payment would be $2,630. That would mean you would have to pay an additional $264 each month.
Current homeowners who hold a variable rate mortgage could also be affected. At Scotiabank, you can either have an adjustable variable rate that fluctuates as BoC rates rise or you could have a variable rate with Cap Rate Protection. A Cap Rate Protection mortgage has fixed payments for the term of the mortgage that are calculated based on a cap rate rather than the current variable rate. As rates rise, more of your payments would go towards interest and less to the principal — but your monthly payment remains the same. However, if you have an adjustable variable rate, the amount you're paying would change as interest rates rise.
A fixed rate mortgage customer would see no impact from a BoC rate increase during the term of the mortgage.
What are the key differences between variable and fixed rate mortgages?
When determining the right mortgage rate for you, you will usually need to choose between a fixed and a variable rate. Each has its own pros and cons so it is important to understand how each one works to make the best decision for you.
Variable rate mortgage
- lower initial interest rate compared to a fixed rate mortgage
- benefit from continued lower interest rate while there are no BoC rate increases
- with a capped payment plan: when interest rates decrease, more of your payments go towards the principal
- if you have an adjustable payment plan: as interest rates decrease, your monthly payment will decrease
- can be converted to a fixed rate mortgage of the same term length or greater, at any time and with no prepayment charge
- with a capped payment plan: as interest rates increase, more of your payments go towards interest
- if you have an adjustable payment plan: as interest rates increase, your monthly payment will increase
Fixed rate mortgage
- same payments for the entire term of your mortgage; benefiting from locking in a favourable rate without the risk of being impacted by BoC rate hikes
- easy to understand and manage, as payments are fixed and the principal paid by the end of the term is known
- higher initial rate compared to a variable rate mortgage
- there is a prepayment charge to break your mortgage that is usually higher than for a variable rate mortgage
Generally speaking, fixed rate mortgages are ideal for people who want the security of knowing that payments will remain the same over the term of their mortgage.
Variable rate mortgages hold appeal because the initial interest rate is lower than fixed rate mortgages (depending on the current overnight rate) and offer greater flexibility than locking in a fixed rate. You can potentially pay less interest over the term of your mortgage with a variable rate mortgage if the BoC has low-to-modest rate hikes. But if the rate goes up this can mean you end up paying more interest.
What's the difference between open and closed mortgages?
Open mortgages have flexible payment options. You can increase your payments by any amount, at any time, with no prepayment charges. Since you can make payments as you please with an open mortgage, the interest rate is usually higher than with a closed mortgage.
Choosing an open mortgage is ideal for people who are expecting extra funds shortly that can be used to pay down their mortgage. This could include an inheritance, proceeds from the sale of a home or a work bonus.
With closed mortgages, there is less flexibility to adjust or make additional payments on your mortgage. Typically, with closed mortgages you have the opportunity to make an additional lump sum payment (up to a capped amount) or increase your payments (up to a capped amount) once a year. Any further payments would come with a fee.
What can you do when there is rate volatility?
Despite the fact that interest rates can increase or decrease at any time, there are a few ways that you can protect yourself.
Get pre-approved for a mortgage
If you're in the process of looking for a home, you can get pre-approved for a mortgage. By doing this, you'll know exactly how much a lender is willing to extend and what your interest rate and terms will be. The rates you get with a pre-approved mortgage are typically locked in for a set period (such as 90-120 days). This allows you to shop for a home knowing that an interest rate increase won't affect you; your rate is locked in. With Scotiabank eHOME, this process has been simplified so that you can get pre-approved digitally – within minutes – from the comfort of your home.1
Choose a fixed rate mortgage
If fluctuating mortgage rates give you anxiety, a straightforward solution is to choose a fixed rate mortgage. All your payments will remain the same for the entire length of your term, so there won't be any need to worry about interest rates for at least a few years.
Convert to a fixed rate mortgage
Most variable rate mortgages will allow you to convert to a fixed rate mortgage. You would have to speak with your lender to see what the steps are, and if there are penalties or fees that you'd have to pay.
Can’t decide between a fixed or variable mortgage?
You don’t have to feel tied down by the decision. With Scotiabank’s Scotia Total Equity® Plan (STEP), you can protect against interest rate changes by customizing your mortgage solution to your risk tolerance.2 STEP allows customers to combine up to three different mortgages with either a fixed or variable rate, and with different terms or length for each mortgage. A ScotiaLine® Personal Line of Credit is another option with STEP that can provide additional flexibility as there is no term or length associated with a line of credit.
What happens to my variable mortgage when there are interest rate increases?
If you have a variable rate mortgage, when the prime interest rate increases this means that your mortgage payment may be higher — which could impact your cash flow and budget.
Your advisor can clearly outline your options and work with you to decide on the best path forward. Contact your advisor to help choose the right mortgage option for you.
This article is provided for information purposes only. It is not to be relied upon as investment advice or guarantees about the future, nor should it be considered a recommendation to buy or sell. Information contained in this article, including information relating to interest rates, market conditions, tax rules and other investment factors are subject to change without notice, and The Bank of Nova Scotia is not responsible to update this information. All third party sources are believed to be accurate and reliable as of the date of publication and The Bank of Nova Scotia does not guarantee its accuracy or reliability. Readers should consult their own professional advisor for specific investment and/or tax advice tailored to their needs to ensure that individual circumstances are considered properly and action is taken based on the latest available information.
1 All mortgage applications are subject to meeting Scotiabank’s standard credit criteria, residential mortgage standards and maximum permitted loan amounts.
2 Subject to meeting Scotiabank's standard credit criteria, residential mortgage standards and maximum permitted loan amounts. A new application may be required to add or change products under the STEP in some circumstances, and if you request a change to the credit limits of your products you may be asked to provide updated information and/or submit a new application. In some cases, a new mortgage registration may be required. The borrowing limit for revolving credit products is 65% of the value of the property. Not all mortgage solutions may be eligible to be included as part of STEP. Additional restrictions and conditions may apply.
The above information should not be construed as offering specific financial, investment, foreign or domestic taxation, legal, accounting or similar professional advice nor is it intended to replace the advice of independent tax, accounting or legal professionals.
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