What Mortgage Borrowers Need to Know About Increasing Interest Rates

What You Need to Know About Increasing Interest Rates

Higher interest rates appear to be in the cards in Canada. At the beginning of September 2021, the Bank of Canada's governor, Tiff Macklem, said that the bank is planning to raise interest rates as it scales back future government bond-buying initiatives. In the background, the inflation rate has been on the rise, and concerns that this trend could persist are growing.

According to several economists, rising interest rates are a risk to Canadian homeowners and mortgage borrowers. A slowdown in rapid house price appreciation from rising interest rates may be welcome but the impact on borrowers may be negative. Even if rates increase only 1%, mortgage payments for some mortgages could increase by more than 50%.

The Impact of Rising Interest Rates on Homebuyers

So, what does this mean for homebuyers seeking mortgages? Well, in general terms, rising interest rates increase the cost of borrowing money, leaving the borrowers themselves worse off. The cost to service the debt increases - in other words, the mortgage payments you are required to make are larger.

Rising rates also mean that borrowers may have access to less funding. Lenders are currently required to use the Bank of Canada qualifying rate when performing the calculations required to determine a borrower’s eligibility. A higher qualifying rate means a higher mortgage payment. This increases the debt-to-income ratio, meaning borrowers will be eligible for less, reducing the size of mortgage that borrowers can carry and still remain within the debt-to-income limits required by lenders.

This represents another blow to home buyers. House prices have been rising, putting buyers under pressure, while inventory has fallen. If interest rates are to rise, home buyers and homeowners will find themselves in an increasingly difficult situation.

Protection Against Rising Interest Rates

How do you protect yourself against potential rate rises? If you are looking for a new mortgage and you are concerned about interest rates rising in the future then you should secure a fixed-rate mortgage.

If you already have a mortgage there are a few things to consider.

• If you currently have a variable rate mortgage

Variable-rate mortgage holders are directly exposed to increasing interest rates. The mortgage payment on your current mortgage will remain the same if you have a variable rate mortgage (this is true for some adjustable-rate mortgages as well), but the amount of the payment that is allocated to interest increases, while the amount allocated to principal decreases. As a result, there is no immediate stress to your personal financial situation, but over time the principal paydown on your mortgage slows, meaning you will pay more over time to service the debt and it will take longer to pay down your mortgage. Note that if you have an adjustable-rate mortgage you should check your documentation to see if the monthly payment will be increased if interest rates increase. This circumstance creates immediate exposure to interest rate increases and may lead you to be more inclined to convert your mortgage to a fixed interest rate in an increasing interest rate environment.

Converting to a fixed-rate mortgage results in you paying a higher fixed interest rate but it will lock in that interest rate for the remaining term of your mortgage, protecting you from interest rate increases. However, how you look at this depends on your risk tolerance. A small, short-term rate rise may be something you can handle — if rates fall again following this, a variable rate mortgage may be the better option. However, if rates move materially higher and stay high for an extended period, a fixed-rate mortgage will likely suit you better

• If you already have a fixed rate mortgage

A fixed rate mortgage shields you from interest rate increases during the term of the mortgage. However, if your mortgage is up for renewal in the coming year or two, you might find yourself exposed to a higher rate environment on renewal. Consider blending and extending your mortgage, locking in current rates on a new mortgage and protecting you for longer.

• If you are currently shopping for a house

If you're in this category, get yourself a mortgage pre-approval. This will lock in your rate for between 90 and 120 days, depending on the lender, from the date of your pre-approval. If rates rise before the end of this rate lock period, you will still enjoy the current lower rate if you close your house purchase within the rate lock period.

Stay Prepared for Potential Changes

Despite the words from the Bank of Canada, there is no way to accurately predict which way interest rates will move. Make sure you are prepared, and understand what a change in interest rates could mean to you.

Here at Frank Mortgage, we provide a refreshingly simple mortgage process, helping you to find the rates you need and to achieve the best deal possible on your mortgage. Use our mortgage payment calculator and mortgage rate discovery tool to learn more, or reach out to our team today for help navigating the mortgage process.