In 2009, Canadian interest rates fell to a historic low of 0.25% in response to the global recession.
Now, after several years of super-low interest rates, Canada’s economic outlook is strong. In turn, the Bank of Canada’s lending rates are going back up.
For people with mortgages or looking to get a mortgage, rising interest rates can cause sleepless nights and tight budgets. But it doesn’t have to be that way. With a basic understanding of Canadian interest rates, you can make wise decisions about mortgages.
Here’s an overview to get you started.
Who Sets Canadian Interest Rates?
Banks, credit unions, trust companies, and other mortgage lenders base their rates on the Bank of Canada’s prime lending rate.
The Bank of Canada is the country’s central bank. It manages the nation’s financial system, currency design and distribution, public debt, foreign exchange reserves, and monetary policy.
Interest rates are part of monetary policy. Adjusting rates and using other mechanisms helps keep the economy healthy.
What Makes Rates Go Up?
The two main factors behind the Bank of Canada increasing Canadian interest rates are economic growth and inflation.
Signs of economic growth include job creation, retail sales, and real estate prices and turnover. When interest rates are low, it’s “cheap” to borrow money and people find it easier to spend money. And spending money is what keeps an economy healthy.
But governments don’t want spending to get out of control. It can increase demand, which drives up prices. Increasing interest rates helps temper spending and keep a good balance between supply and demand.
Too much demand compared to supply can creates inflation. If the price of basic products and services such as groceries and housing prices keep going up, the value of money goes down. That is, each dollar has less purchasing power. That’s inflation.
Increasing the cost of borrowing money cools the purchasing cycle and can keep inflation in check.
Why Are Rates Going Up Now?
Canadian interest rates started increasing in 2017 because the economy showed signs of stable strength. Unemployment rates were low, which was good. But real estate prices, especially in Vancouver and Toronto, continued to increase.
This became a major concern from the monetary policy perspective. People were borrowing larger and larger sums to buy property because the cost of borrowing was low. Increased real prices were making too many people put themselves in risky financial situations.
Interest rates went up twice in 2017, each time by .25%. At the end of the year, the Bank of Canada’s prime rate was 1%, a 100% increase from the same time the year before.
The rate rose again by .25% in January 2018 putting additional pressure on individuals and businesses needing to borrow money.
Other measures were also taken to help cool the real estate market and prevent more people from over-extending themselves financially.
On January 1, 2018, the government implemented a new mortgage qualification stress test for anyone buying a property. The goal is to ensure purchasers can still afford the mortgage if interest rates increase by 2%.
Before You Buy a Property
It’s more important than ever to know your budget before shopping for property. Use a mortgage calculator to get a sense of your monthly costs. Be realistic when thinking about income security and potential large unexpected expenses.
Talk to your bank about a pre-approved mortgage. And don’t be shy about shopping around. Saving even a quarter of a percent on your interest rate can make a big difference to affordability.
Also, talk to lenders about shorter amortization periods. Shorter amortization means higher monthly payments but less going to interest. In the end, you pay the mortgage off sooner and at a lower overall cost.
Protect Yourself Against Further Increases
With Canadian interest rates rising, the best way most people can protect themselves from higher mortgage costs is to lock in the rate.
If you can afford it, also shorten the amortization period as much as possible. Plus, make payments every two weeks instead of every month.
This scenario offers three benefits.
First, knowing that the rate won’t increase for the duration of the mortgage term removes uncertainty and makes budgeting easier. When deciding what term to choose, think about how the likelihood of needing to renew the mortgage at the end of term and where you think interest rates will be.
The benefit of a shorter amortization is that you’ll have less of balance at the end of the term. So, even if interest rates are higher, the principal will be smaller.
Paying every two weeks instead of every month is a simple way to further reduce the principal and interest payments during the term.
Variable rate mortgages and home equity lines of credit are good options under specific circumstances. Because mortgage interest rates change each time the Bank of Canada makes a change, variable and home equity mortgages can be riskier for borrowers. Your banker or financial advisor can help you know if these kinds of mortgages are right for you.
Adjust Your Expectations
It’s probable that Canadian interest rates will continue to rise throughout 2018. The trend may continue into 2019. That kind of outlook can put added stress on household budgets.
The best thing you can do as Canadian interest rates rise is to adjust your expectations to the new reality.
If you’re looking for a new home, look for properties that you can improve over time while living comfortably now. Don’t underestimate the value of building equity without undue financial burdens.
People looking for investment properties also need to hope for the best but plan for the worst in terms of interest rates. If you’re a long-term investor, higher interest rates could be balanced out by lower rates down the road. Short-term real estate investors need to prepare for extended costs from a shortage of buyers or lower prices when it’s time to sell.
Even if the cost of borrowing increases, owning property can be a wise and rewarding investment.
If you’re looking to buy in the Greater Vancouver area, our friendly and knowledgeable team is ready to help. We will keep your best interests in mind as we help you find and secure your next home or investment property. Contact us today to get started.