INTEREST RATES – Q&A
In light of today’s Bank of Canada Interest Rate Change, we wanted to answer as many questions as we could think of and give you details for all options. The biggest takeaway any client should have from this information is to reach out to your Broker if you have any unanswered questions. Especially those looking at fixing your rates.
The Bank of Canada announced today a 0.75% increase in its overnight lending rate. From 2.5% to 3.25%. This will have a knock-on effect on all Bank’s Prime Rate and will move to 5.45%. (Some Lenders such as TD being an exception as they have their own Prime Rate 15 basis points higher)
WHAT DOES THIS MEAN – EXISTING MORTGAGE HOLDERS
Fixed rates – if you are in a fixed rate, this rate increase does not affect your current mortgage. But a few things to note. You should know your maturity date and plan well in advance. After all, the thing that costs clients the most amount of money when it comes to mortgages is a lack of preparation
VRM – Variable rate mortgage with a static payment. While this rate increase will not affect your payment, it will affect your ratio of Principal and Interest within that Fixed payment. But some VRM mortgages are nearing their trigger rate. This is when the amount of interest within the fixed payment exceeds the total amount of the payment and puts you into a negative amortization scenario. When and if this trigger rate is reached your Financial Institution will discuss your options to put yourself in a positive amortization scenario again. These options will include: 1) to make a lump sum payment. 2) to switch into the current fixed rate available for the remaining term of your mortgage. 3) to increase your payment manually to cover the interest portion.
ARM – Adjustable-rate mortgage with a floating payment. This rate increase will have a direct effect on your payments. By roughly $45 per $100,000 borrowed. But keep in mind you are paying off the mortgage at the same amortization schedule that was set out for you on day one.
WHAT DOES THIS MEAN – SOON-TO-BE MORTGAGE HOLDERS
Approved – this will not affect your approved amount. But may affect your payments come closing day depending on the product you have chosen
Pre-Approved – depending on the rate in which you were stress tested from for your Pre-Approval (which Likely was a variable rate) your qualification rate, or stress tested rate, will have increased by 0.75% this in turn will reduce qualification by on average 8%. We encourage all Pre-Approved Clients that do not yet have an approval to touch base with their broker to make sure their budget still aligns with what they are looking at.
Maybe the most important factor in why you chose the product you did. Remember the types of penalties and the interest rates in which they are associated with. IRD vs 3-month interest penalties. When you chose your product, you would have looked at the likelihood of you incurring a penalty. Are those chances still the same? Are they higher? Or lower? Things to consider.
HOW ARE PENALTIES CALCULATED?
You will always be charged the higher of the two penalties when you break your mortgage. whether than be from selling or refinancing. But knowing how the two penalties are calculated is a great asset in helping you decide which product you should be in.
3 Month interest. This is the easier of the two to calculate. Take the interest portion of your monthly payment at the time of breakage and multiply it by three.
IRD – Depending on the Lender, this could mean a comparison between the posted rate at the onset of your mortgage, compared with the posted rate for the remaining term. In a Market where rates have fallen, this penalty can be substantial.
CAN YOU SWITCH TO A FIXED RATE?
Yes you can switch to the Fixed Rate that is available at the time with your current Financial Institution
Current Fixed Rates are in the 5% to 5.5% range for 5-year terms
You can switch to the fixed rate ON OFFER for at least the remaining term
Remember – you do not “lock in what you have”, you are “switching to the current fixed rate available”
You could look at switching to another Financial Institution as the Fixed Rates they have may have better rates than that of your current Lender. This will mean the breakage of your current variable rate mortgage and mean you incur a penalty, but the other Lender’s rate may be better.
IS THERE A PENALTY FOR SWITCHING TO A FIXED RATE?
No there isn’t a penalty to switch to a Fixed Rate with your current Lender.
This is because the Lender knows the chance of you then leaving them is now incredibly slim.
IS THERE A PENALTY TO BREAK A FIXED RATE?
Yes, there is, and, in the future, we anticipate this could be very high
When rates start to come down again, those penalties could be in the $10,000s and $20,000s
CAN YOU SWITCH TO A SHORTER-TERM FIXED RATE?
Yes, you can. Doing this will result in breaking your variable rate with a 3-month interest penalty and refinancing to a shorter term. This will be subject to qualification.
CAN YOU SWITCH BACK FROM A FIXED RATE TO A VARIABLE RATE?
Not without breaking that Mortgage and paying what possibly could be a large penalty
WHAT IS THE PENALTY TO BREAK A VARIABLE RATE MORTGAGE?
There is a 3-month INTEREST penalty to break a Variable Rate Mortgage
WHAT IS THE PENALTY TO BREAK A FIXED RATE MORTGAGE?
The penalty is the higher of 3 month’s interest or the IRD, Interest Rate Differential
The latter is based on the Lender’s posted rate, and when rates are falling this penalty can be substantial
CAN I TAKE A ONE YEAR TERM IF MY MORTGAGE STILL HAS 4 YEARS LEFT TO RUN?
No – if you want to avoid any penalty
Yes – if you are ok paying a 3-month interest rate penalty
If you wish to “switch” to a fixed rate, then you can switch penalty free for at least the remaining term
SHOULD I SWITCH TO A FIXED RATE IF I PLAN TO SELL IN THE NEXT FEW YEARS
I wouldn’t recommend doing this as you will potentially have a substantial penalty in the future when you pay out that mortgage
If the plan is to flip or sell in the next 2-3 years, then remember your strategy and stay with the variable as the penalty is considerably lower
CAN I CONSOLIDATE MY LIABILITIES?
If you are looking at consolidating liabilities, we still encourage you to look at doing so through your mortgage. Remember, interest rates on your credit cards, personal loans, LOC’s and vehicles are very likely higher than that of a mortgage.
If you have debt, it is still incredibly beneficial to refinance
WILL THE BANK OF CANADA RAISE RATES AGAIN?
The Bank of Canada has indicated that they plan to continue its current path until inflation has returned and is stable at their goal of 2%. Our own Chief Economist Dr Sherry Cooper believes we will see another rate hike before the end of the year. And depending on the current status of inflation will not see any rate decreases until 2024.
BoC has expressed that this will not be pain-free during the next 12 months while they combat inflation. But looking at the bigger picture, entrenched inflation is a bigger problem than the country going into mild recession. The BoC’s main goal is to curb inflation.
WHY IS THIS HAPPENING?
Obviously, we had the most unexpected happen and suffered a worldwide pandemic that could never have been predicted. The Bank of Canada along with National Banks the World over went into emergency mode of helping their Citizens and saturated the market with money, what we call Quantitative Easing, flooding the market with cash.
They also stepped in to help many who were suffering financially. This was needed and we understand that, but it had several effects. It gave us a false sense of economy and we soon got used to lower than normal rates. We were unable to do anything for so long that when these restrictions reduced, we all went out into the World again to enjoy ourselves, spend money, go on vacation etc.
Supply and Demand became unsustainable. We expected a steady return to “normal” whatever that was meant to look like financially. The BoC themselves in 2020 and into late 2021 still predicted they would keep interest rates low throughout 2022 and into late 2023. This of course hasn’t happened. A War came along which further exacerbated the supply and demand situation.
We currently have the lowest unemployment for decades whilst at the same time, we have more people employed than pre-pandemic. ie more jobs available than we have people to do them.
All of this means that the World went into a tailspin – one that could not have been predicted. The Central Banks are now acting aggressively to halt that tailspin of rising inflation.
WHAT SHOULD YOU DO?
If you would like peace of mind, knowing that your payment is not going to change for the next 5 years for example, then look to a fixed rate.
Pro’s – Your payment and interest rate will stay the same for the Term of your Mortgage and any future rate changes will not affect you.
Con’s – If rates fall in the future when inflation is back in line, you may have a large penalty to break that mortgage in order to drop your rate.
If you feel more comfortable with your rate moving up and down, and like the freedom associated with variable rate mortgages and the flexibility they provide, then stay variable.
Pro’s – When rates fall, your payment will also fall and if another Financial Institution has a larger discount from Prime, you have the flexibility to cheaply move your mortgage and take advantage of all options.
Con’s – If the BoC continues to raise rates, your payment could increase further.
- Always call your Broker before doing anything to your current Mortgage
- Making the best decision with the information available at the time should always be the first thing on your mind
- Remember what goes up can just as easily come down
- While the recent rate hikes are not expected to fall again until early 2024, truth of the matter is no one can predict the future. Just think what happened in 2020
- Do not take on new debts
- Consider adjusting your budget
- Are there areas within your budget that could be cut back?
- Analyze your situation
- Keeping track of where your money goes is a great way to limit the unnecessary spending and to keep yourself in line. We recommend downloading a budgeting spreadsheet and keeping track of every single dollar you spend.
We hope this answers as many questions as possible but please do reach out if we have missed anything or indeed to discuss your individual situation.