The Bank of Canada is pulling the economic purse strings tighter, hiking its overnight lending rate to a full 1 per cent – the second upward move in 2017. The Bank rate is correspondingly 1.25 per cent, and the Deposit rate is 0.75 per cent.
It’s the highest the BoC’s trend-setting rate has been since 2015, when it was slashed in two moves to half that in response to dropping oil prices. Now, with the economy back on track, Canada’s central bank feels it can ease up on the safeguards it had in place to weather the recession.
“Given the stronger-than-expected economic performance, Governing Council judges that today’s removal of some of the considerable monetary policy stimulus that is in place is warranted,” the BoC states. It reports that consumer spending, employment and income growth, business investment and exports have performed well. This has propped up GDP as the housing sector “appears to be cooling in some markets in response to recent changes in tax and housing finance policies.” While inflation – a main measure that traditionally influences the BoC rate – remains below its 2-per-cent benchmark, it has “evolved largely as expected in July”.
The global economy is also strengthening, particularly as prices rise for industrial commodities, thought the BoC warns that geopolitical risks and uncertainties remain, which has weakened the US Dollar and boosted the Loonie.
What Does a 1% Rate Mean for Borrowers?
The Bank of Canada’s Overnight Lending Rate is used by Canada’s consumer banks when pricing their Prime rates, meaning the cost of borrowing for variable loans and mortgages fluctuates alongside any rate hikes or cuts.
In July, when the BoC hiked its rate from 0.5 per cent to 0.75 per cent, all five of Canada’s big banks (Scotiabank, BMO, TD, CIBC, and RBC) increased their Prime rates from 2.70 per cent to 2.95 within 24 hours. This time around, they’ve followed suit with an increase to 3.2 per cent.
That means your line of credit or variable-rate mortgage is going to become more expensive, though by how much will be at the discretion of your lender.
For example, using a mortgage calculator, let’s assume a borrower has a five-year variable-rate mortgage at 1.99 per cent (Prime – 0.96) on a $500,000 home – the lowest rate currently offered on the market. Also assuming they have a 25-year amortization and have paid a 5 per cent down payment, their monthly mortgage payment will be $2,089.
Now, let’s assume that this particular lender prices in the full 0.25-per-cent increase. That means their rate has fluctuated to 2.24 per cent, hiking their monthly mortgage payment to $2,150. That’s an extra $61 per month, or $732 per year.
While this may seem daunting for borrowers, however, keep in mind that variable is still priced below today’s lowest fixed-rate mortgage (currently 2.64 per cent). Assuming instead that our borrower locked in, they’d be paying $2,248 per month – $98 more than the hiked variable.
It’s important for borrowers to keep their personal risk tolerance in mind in a rising rate environment. If a variable mortgage rate still makes financial sense, and you know your budget can withstand a higher mortgage rate, let that determine what your strategy. It’s also a great idea for prospective mortgage borrowers to factor in an affordability cushion of 2 per cent when establishing their max home buying budget, and to always get a pre-approval.
Are More Rate Hikes on the Way?
Analysts have speculated that, as long as the economy continues to grow, that the Bank of Canada may factor in more rate increases next year. Doug Porter, Chief Economist at Bank of Montreal, stated in a previous research note that the Bank expects rates to settle at 1.50 per cent by the end of 2018 – that’s two more hikes, at the BoC’s current pace.
However, the BoC says it will look to the “economy’s potential and to labour market conditions” to guide whether it will make another move, keeping in mind high levels of household debt, which could be negatively impacted should borrowing become too expensive, too quickly. “…given household indebtedness, close attention will be paid to the sensitivity of the economy to higher interest rates,” it states.
A higher Prime rate may also influence the “stress test” rate lenders must use when qualifying borrowers with less than a 20-per-cent down payment for a mortgage. Based on an average of the big banks’ Prime, it rose 20 basis points from 2.64 to 2.84 per cent in July in response to the hike. Assuming regulators choose to pass along the increase this time, all high-ratio borrowers will now be required to qualify at 3.04 per cent.