Having an interest rate hike for home mortgages can mean significant impacts on your budget and financial bottom line. Later this morning, the Bank of Canada will announce whether or not they will raise the overnight rate, impacting Canadian home buyers and driving interest rates up.
Bets are the Bank of Canada Governor, Stephen Poloz, will end up announcing a rate hike today. The national bank left its target rate at 1.5% after their last rate announcement on September 5, 2018. Economists have been predicting a rate increase and the bank’s policymakers have consistently reinforced their viewpoint that higher interest rates will need to rise in order for the country’s inflation target of 2% to be met.
So, what does an interest rate hike mean for everyday Canadians? The question to be answered is: How will an interest rate hike effect me?
The direct impact on most people is minimal, but that doesn’t mean consumers will walk away untouched. Here are five ways an interest rate hike will impact your budget and what to keep in mind.
No. 1: Loans are more expensive
Essentially, any interest rate hike will mean more money in the bank for savers and lenders but less for those borrowing money. Wait? Does this mean an interest rate hike will impact me if I’m buying a house? Yes. It will also affect you if you’re looking to refinance or renew my mortgage (but like all things loan related, the impact of this change will be greatly reduced if you have less debt and a great credit score).
That’s because rates offered on personal loans, HELOCs and variable-rate mortgages all depend on a lender’s prime rate, which is directly impacted by the Bank of Canada’s overnight target rate. If the BoC’s rate rises, so do a bank’s prime rate, which means the interest rate you pay on your loan also increases — and the cost of borrowing that money becomes more expensive.
For those shopping for a mortgage — either because you just bought, plan to buy or you need to renew or refinance — you’ll notice an increase in the rates offered on variable-rate mortgages. This means it will now cost you more to borrow money.
For those currently with a variable-rate mortgage, you may not notice the immediate impact of the rate change. That’s because many variable-rate mortgage-holders will continue to pay a fixed monthly amount. A lender can choose to raise your monthly payment, or keep it the same. While not immediately raising your current monthly payment may seem great — it’s not. Now, more of your current monthly payment will go towards interest, rather than paying down the principal debt. The result is that at the end of your mortgage term, you will have a higher mortgage debt balance.
No. 2: Cost of credit card debt goes up
While an incremental rate rise, say of 0.25%, should have little impact on a credit card interest rate repeated rate increases will eventually push credit card interest rates up higher. Considering most credit card rates start at 18%, any increase will make it more expensive for the 42% Canadians who don’t pay off their credit card balance each month. a balance on their credit card.
While a rate increase on credit cards won’t happen immediately, rates on personal loans HELOCs and variable-rate mortgages will rise within hours and days of a Bank of Canada rate increase announcement.
No. 3: Consumer spending will slow down
The most direct impact a rate hike has on consumers is a change in our spending habits.
Interest exists in the first place to allow borrowers to spend money immediately, rather than waiting to save up money to make a purchase. With lower interest rates, more people are willing to spend more money to make big purchases on items such as cars or homes. That’s because when consumers are paying less interest it gives them more money to spend overall, and creates a ripple effect of increased spending across the broader economy.
Conversely, higher interest rates mean that consumers will not have as much disposable income to work with and will likely cut back on spending. Higher interest rates are often coupled with increased lending standards at banks, which decreases the overall number of loans.
Some economists estimate that a 0.25% increase in interest rates reduces overall household spending by 0.4% (while a 0.25% reduction in interest rates increases income by 0.15%).
No. 4: Savings will increase
The theory is the higher the interest rates, the more people save. The reasons are two-fold: It costs more to borrow, so people cut back on spending; and it pays more to save because you earn a higher interest. Sadly, however, savers are unlikely to see any significant benefits of the Bank’s incremental rate rise. While banks tend to push through rate rises on mortgages immediately they are much slower to raise savings rates.
At present, most big bank regular high-interest savings accounts offer interest rates between 0.50% and 1.50%. EQ Bank Savings Plus gives savers 2.3%, while Scotiabank has a time-limited offer (until March 2019) that offers savers 2.99%.
There is another way rising rates impacts savings: They prompt investors to select how they’ll invest their money. Remember, returns on both GICs and bonds are directly affected by the overnight rate. That’s because there is an inverse relationship between bond prices and interest rates.
A rise in interest rates is associated with bond prices falling. But rising rates also affects the equity markets. When interest rates are rising, businesses and consumers cut back on spending and earnings begin to fall which prompts stock prices to drop accordingly.
This said any rate rise may actually be beneficial for retirees who choose to buy an annuity – a financial product that provides an income for life. Rather than savings, this ‘guaranteed income for life’ insurance product can be expected to provide a greater yield as a result of the increasing interest rates.
No. 5: Impact on the value of the dollar
A rate increase will attract more foreign investors to Canada and this can push up the value of the dollar, making vacationers happy, right? Sadly not. Even though the rate rise has been widely anticipated, the Canadian dollar appears to be in its comfort zone of around $0.70 to $0.75 cents when compared to the U.S. greenback. So, unless there is a sudden economic shift on either side of the Canada/U.S. border, expect the dollar to remain in this comfortable band. (But, hey, anything can happen.)
Is this just the start of many more rate rises?
Possibly. While few economists expect a return to the 5% prime rates that were common before the 2008/2009 financial crash, many expect BoC overnight rates to eventually rise to the “new normal” base rate of no more than 2% to 3%. As of October 15, 2018, the current BoC prime is 1.5%.
Did you know: Interest Rates in Canada averaged 5.89% from 1990 until 2018, reaching an all time high of 16% in February of 1991 and a record low of 0.25% in April of 2009
This eventual increase to the “new normal” prime will put intense pressure on household finances. Essentially, if the Bank of Canada raises the base rate by another 1.5% — to an overnight rate of 3% — then borrowers across the country are going to feel the strain.
Here’s why: In 2018, the average prime lending rate was 3.45%. For those on a variable-rate mortgage, this would mean a monthly mortgage payment of approximately $2,485 (based on a $500,000 mortgage, amortized over 25 years). Now, let’s say bank prime rates rise in tandem with a BoC rates increase to 3%, that would put variable rate mortgages at 4.95% (and those rates would be reserved for only the best borrowers). Monthly payments on this new rate would now be $2,895 — an increase of more than a $400 per month.
Perhaps this is why we are beginning to see more competitive 10-year fixed rate mortgages, which are only marginally above the five-year fixed rates. For example, Coast Capital (a B.C.-based credit union) offers a 10-year fixed at only 4.14%, while mortgage brokers are offering rates as low as 3.89%. Now compare this to the current 5-year fixed rates which hover around 3.25% to 3.5% — meaning five years of security will cost you less than 100 basis points.
What impact will a rate increase have on the property market?
In active markets, such as Greater Toronto or Greater Vancouver, expect interest rate hikes to help further suppress market activity. This, in turn, will help suppress price increases (or could prompt price reductions in some market segments). In less active markets, such as Calgary, the rate increases could prolong housing market recovery by further reducing sales activity.