July 13th Rate Announcement: Bank of Canada increases the Prime Rate rate by 1%.
Topics Covered:
- Prime Rate increases by 1%— raising it to 4.7%
- How will any changes in interest rates affect your mortgage?
- Today’s Rate Announcement Details
- Prime Rate effects on variable rate mortgage holders
- Should you lock into a fixed rate?
- The housing market will continue to tighten
- Housing sales and prices are on the decline.
- Will Higher Rates Lead to a Recession?
How will any changes in interest rates affect your mortgage?
With recent Bank of Canada interest rate hikes, here is what you need to know about how these fiscal policy changes affect your mortgage. First and foremost, the interest rate hikes directly affect individuals that currently have an adjustable-rate mortgage.
Variable mortgage holders
Depending on your mortgage amount, you’re looking at a potential mortgage payment increase of $57 per month for every $100,000 of the balance owing. For example, if your mortgage balance is $500,000 then your monthly payment will increase by approximately $285 per month. As Canada’s lending prime rate has increased, variable rates increase as these rates are tied to the prime rate. Payments need to increase respectively to ensure the scheduled amortization remains the same. Hence you will still pay off your mortgage as the original amortization shows.
Fixed-rate mortgage holders
For those individuals on a fixed mortgage, you will not be affected by these interim changes outside of renewing your mortgage. If your mortgage is up for renewal, you will likely be renewing at a higher rate depending on your lender. If you’re still six months away from renewing, it may be a good idea to look into the options for early renewal to avoid getting caught up in another interest rate hike later this year. All rates, fixed or variable are expected to rise more over the summer months. Please reach out to me today to discuss obtaining a rate hold. I can lock in an interest rate for 90-120 days while you plan your next step whether it is renewing, purchasing or planning for changes.
Not yet a homeowner?
If you’re not currently a homeowner but were looking at getting into the marketplace, it is a good idea to revaluate your budget and potential calculations for homeownership to ensure that your estimates are in line with the new interest rates. While interest rate hikes affect everyone, understanding the dollar value change for your situation and adjusting your budget accordingly, can help ease the pressure from increased mortgage costs. If you have any questions or are not sure what your next move should be, don’t hesitate to reach out to me today! I’d be happy to help review your situation and walk you through your options.
Today’s Rate Announcement Details
Today the Bank of Canada (BoC) has made its fourth consecutive rate hike since March. They have made the decision to increase its overnight lending rate by 100bps, or 1%. Most economists were estimating an increase of as high as 75bps (0.75%), however, the BoC has gone ahead and made the largest increase we have seen in over 24 years. As the consumer lenders’ Prime rate is based on the overnight lending rate, consumers can expect to see today’s 1% hike phased in shortly, bringing the prime rate to 4.7% from the previous 3.7%. That’s going to drive five-year variable interest rates for “A” borrowers from their current range of 2.5 – 3.4% to 3.5 – 4.5%.
Tighter monetary policy is also expected to increase fixed mortgage rates, which are already around 4 – 6%. As many may know, fixed rates are tied to the bond market. Bond prices are currently at 3.1% this morning. Markets expected an increase in rates, but this larger 1% hike may have increased bond investor demand even more.
Considering locking into a fixed rate?
Before considering locking into a fixed rate, please read our blog about the consequences and other important factors to consider. As always, we suggest giving us a call for a free consultation about what’s best for your unique situation.
How the Prime rate increase will affect the stress test
In addition to today’s hike, the 5.25% mortgage stress test threshold will become obsolete as a consequence. A borrower must prove that they can afford to carry the loan at this rate, or the contract rate plus 2%, whichever rate is higher. As a result of a 1% increase, all five-year variable mortgage rates will reach above 3.5%. Making the latter criteria of your net rate +2% the new measure. As lenders phase in their Prime rate hikes, OSFI is expected to raise the stress test threshold to 6.09%. This is the highest level since the stress test was introduced. Therefore, future homeowners’ borrowing power will be affected and many will be discouraged from purchasing second homes.
Tiff Macklem, the governor of the Bank of Canada has released the following as his opening statement as to why these decisions were made:
“I want to explain to Canadians why we’ve made this decision. There were three key considerations.
First, inflation is too high, and more people are getting more worried that high inflation is here to stay. We cannot let that happen. Restoring price stability—low, stable and predictable inflation—is paramount.
Second, the Canadian economy is overheated. There are shortages of workers and of many goods and services. Demand needs to slow so supply can catch up and price pressures ease.
And third, our goal is to get inflation back to its 2% target with a soft landing for the economy. To accomplish that, we are increasing our policy interest rate quickly to prevent high inflation from becoming entrenched. If it does, it will be more painful for the economy—and for Canadians—to get inflation back down.”
TIFF MACKLEM, GOVERNOR OF THE BANK OF CANADA
Breaking down the 1% rate hike
The consensus is clear, the goal is to offset longer-term inflation by increasing short-term interest rates. After 30 years of low, stable inflation, many Canadians are experiencing the pain of high inflation—and the uncertainty that comes with it. Over half of the components in the consumer price index (CPI) basket are rising above 5%. When inflation is this high, it erodes the purchasing power of every Canadian.
As in many countries, inflation is driven by the war in Ukraine and disruptions in the supply chain. Inflation in Canada and around the world has been pushed upwards by global energy and goods prices. As the Canadian economy grows more vibrant and open, inflation is broadening. We are experiencing an excess of demand for goods and services. Which is making it impossible to meet the demand as people enjoy a fully reopened economy. Due to the lack of workers, employers are increasing wages to attract and retain employees. The robust economy is causing businesses to raise prices to offset higher input and labour costs.
Trying to control Demand and Supply
With higher interest rates, demand will slow and supply will catch up. As pent-up demand from pandemic restrictions eases and borrowing costs increase, consumer spending will moderate. During the pandemic, housing market activity soared to unsustainable levels, and our exports will be reduced as global growth slows.
The prevailing view in consumer and business surveys is that the Bank of Canada will ultimately control inflation. At the same time, these surveys clearly suggest inflation expectations have moved up and are becoming more dispersed, with more respondents confirming the persistence of high inflation.
The housing market will continue to tighten
Mortgages that have variable rates are closely linked to the central bank’s rate. So the impact of higher rates will be felt most directly in the housing market. For most of the pandemic, Canada’s housing market was in high demand and prices hit record highs. However, the direction changed in the first part of this year, after the central bank signalled that higher rates were on the horizon. With rates increasing, housing prices have begun to descend and bidding wars have begun to neutralize as both purchasing power and the amount the average borrower qualifies for have begun to decrease.
Average housing prices have fallen since March across the country, the Canadian Real Estate Association says. Wednesday’s rate hike will do nothing to reverse that trend.
Real Estate Sales and home prices are on the decline
June’s MLS sales were down by 13% from May. Exceeding the typical seasonal decline for the third consecutive month (in this case, 4%). The average daily sales in June were 167 in total. Making it 17% lower than May’s 202 sales, and 38% lower than June 2021’s 271. Additionally, June’s sales total was the second lowest in more than a decade. On a year-over-year basis, sales were again (predictably) lower across all home types. Detached home sales were down the most, at 51%. Followed by townhome and condo sales, which were lower by 35% and 28%, respectively.
Median MLS sold prices in both the Greater Vancouver and Fraser Valley board areas declined in June by 2% versus May, on average, across both board areas.
For detached homes and condos, the Greater Vancouver board area experienced a month-over-month decline of 5% and 3%. Which exceeded the 4% and 1% respective declines in the Fraser Valley. The median townhome sold price in the Greater Vancouver area actually rose by 0.3%. While it declined by 1.7% in the Fraser Valley.
On a year-over-year basis, median prices remained relatively higher in the Fraser Valley than in the Greater Vancouver board area across all home types. With condos up 20% (compared to 10% in the Greater Vancouver area), townhomes up 18% (compared to 14%), and detached homes up 14% (compared to 10%).
Will Higher Rates Lead to a Recession?
An analysis of potential rate scenarios released by CMHC just this week stated that if the BoC rate reaches 3.5% by 2023, consumer growth will be curtailed, resulting in a 5% decline in national home prices, a 34% drop in national home sales, and a 7% rise in unemployment. During the next two quarters, recessionary effects would persist.
Given there are three more rate announcements scheduled for this year, should the BoC implement a minimum of 0.25%, or 25bps, in each, the overnight lending rate will indeed rise to 3.5%, the upper end of its neutral range.
The next rate announcement will be September 7th, 2022.
