The Bank of Canada raised their policy rate for the fifth time on September 7th, up 0.75%, to combat inflation. The overnight rate is now 3.25%. Canadian banks’ prime rates increased to 5.45%.
While the latest increase was smaller than the move made in July (1%), it is bigger than the changes made in March (+0.25%), April (+0.50%) and June (+0.50%) and is a larger increase than most had forecasted.
The Bank of Canada stated it is not finished hiking its policy interest rate just yet and noted that central banks around the world also “continue to tighten monetary policy.”
Anecdotally, the Vancouver market seems to be humming again after a rather flat August. I’ve received more calls and emails in the past week than I have in the past several weeks. However, I have a feeling that going forward, seller’s will be adjusting their initial list prices to accommodate for these interest changes.
Let’s Talk Affordability:
The discount off prime for most mortgages is now anywhere from 0.9% to .3%. What this means is that rates are 5.45% – 0.9% = 4.55% to 5.45% – 0.3% = 5.15%.
The qualifying rate is 2% above contract rate. If someone has a rate of 5.15%, they will have to qualify as though their mortgage is at 7.15% interest. Yesterday, the qualifying rate would have been 6.15% for the same borrower.
Ok, so let’s take an income of $100,000. Yesterday, if you were going with a variable rate, your affordability would have been a mortgage of approximately $530,000 (assuming no other debt). Today, qualifying with the variable rate provides a mortgage of approximately $482,000.
Two months ago, the same income provided for a $585,000 mortgage.
This is about a 10% decrease in affordability. This change, along with the other increase in July, provides for a 18% decrease in affordability over 2 months.
Payment Changes:
For an adjustable-rate mortgage, this 0.75% increase increases a person’s mortgage by around $45 per $100,000.
Please remember variable rate mortgages encompass adjustable-rate mortgages and variable rate mortgages. However, they are not the same product. Adjustable-rate mortgages change their payment when the rates change. Variable rate mortgages change the proportion of interest to principal. Scotiabank is the only bank that has a true adjustable-rate mortgage. All other banks have variable rate mortgages.
The issue here is that for most homeowners, when they got their variable rate mortgage, their payment was based on a sub 2% rate. Now that their rate is going up to around 5%, their payment may not cover their interest portion of the mortgage. If this happens, the mortgage amount will increase.
Example: Mortgage is $500,000 and payments are $2,000. The interest has increased to a point where the interest portion of the payment alone is $2,100 per month. If no changes are made, the mortgage will be at $500,100 next month. The problem here is that A) the mortgage is not being paid off, and B) next month the interest portion will be higher because we’re now paying interest on the $100 of interest.
Blanket Advice:
If it is the case that your interest is above the actual mortgage payment you can do a monthly “lump sum” or “pre-payment” (but not a continuous increase in your monthly payment) on any overage so that interest does not increase your mortgage amount and that interest is not paid on interest.
If you have any questions about how the rate increases will affect your property, don’t hesitate to give me a call. If you have any questions specifically relating to your mortgage, I know several highly skilled mortgage brokers that would be happy to help.