What happens to my mortgage payments when interest rates are going up?

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Last updated on February 23, 2022

Everyone knows that buying a house can be a lengthy and complex process. So, it’s better to be safe than sorry. Create a budget and learn about the types of mortgages available and how interest rates going up could impact financing your property. 

According to the Canadian Real Estate Association (CREA), this is projected to be the second-best year on record for home sales in the country. However, with the rising inflation rate, paying bills has become one of the main worries of Canadians this year, and adding a mortgage on top of that could be extremely difficult for some. A recent survey from Angus Reid found that half of Canadians consider the price of a home in their city extremely high, but close to 25% understand these high prices depending on the area. 

Recently, the Bank of Canada announced that Canadians should prepare for interest rates going up sometime between April and September of this year. Whether you’re buying your first home or investing in a second mortgage, having a clear understanding of interest rates and how they affect home buyers’ ability to afford their property can ease the process. Luckily, there are also financial tools with specific features to plan your budget and test mortgage scenarios to help in the property buying process. 


What can impact interest rates in Canada?

Before we get into the nitty-gritty of the multiple things that can make interest rates increase or decrease in Canada, let’s clarify what is an interest rate? To put it simply, it’s the cost of borrowing money. It determines how much the lender would receive from you. So, if you’re buying a house, it directly affects the installment loans you’d pay back to your lender. 

There are a few reasons interest rates could rise in Canada. For starters, the Bank of Canada determines the interest rate in the country; however, other economic factors also impact the annual percentage rate, such as the growth of the Consumer Price Index (CPI), the global economy, the country’s economic growth, among others. 


The Bank of Canada can raise interest rates

Committed to maintaining low and relatively stable inflation in Canada, the institution is responsible for setting monetary policies, printing money, and fostering a sound and efficient financial system. The Bank of Canada aims to keep inflation between 1 and 3 percent, the ideal rate of inflation range. Setting a target rate for inflation helps the Bank enforce measures that will ensure Canadians are compensated proportionately for the higher cost of living if the cost of goods rises and affects consumer goods’ prices. 

To illustrate, at the beginning of the 2020 pandemic, the average inflation rate in Canada was set at 0.72 percent, the lowest it’s been since 2010. With many people losing their jobs or being put on leaves, buying behaviour reinforced the inflation target. Although people were spending less on consumer goods, the meaning of home expanded from just one’s residence to be an office, school, gym, which fueled the housing market. House prices defied the low inflation rate and, according to CREA, 2020 had a new annual home sales record with 12.6 percent more than 2019. 

The latest spike in Canada’s annual inflation rate in 2021, reaching its highest in the last 20 years at 4.8 percent, resulted in higher prices for food and other consumer goods and housing. Even though house prices rose 16 percent in 2021, the housing market set another annual record in sales, which investors and corporations who were looking to place their extra capital significantly contributed to. 


Inflation result in higher interest rates

As mentioned, inflation rates impact Canadians’ consumer behaviours and wages, which compensates for higher costs of living. Since 2020, the low lending rates have allowed for record-low mortgage rates; however, this contributes to a higher demand and, consequently, price growth as seen for these past two years. 

With more and more people borrowing money from investors and expanding their business or other personal projects, the money supply is expanding and the price of goods and services go up. When inflation is higher than 3%, it increases the likelihood that the Bank of Canada will increase the interest rates. 


International loans with higher interest rates

Canada borrows money from many countries, but mainly from the United States. Therefore, foreign interest rates will impact Canada’s interest rates as well. 

In addition, the higher the interest rates are in Canada, the more valuable the Canadian currency valuation, which attracts foreign investments in the country and improves economic growth. Finally, political and economic stability also play a huge role in defining a country’s currency valuation.

Having a clear understanding of what impacts the interest rates in Canada can help you plan properly and adjust to take on bigger projects, such as buying your forever home. For example, interest rates going up can affect your mortgage and determine if you would live in your house after you buy it. 

Essentially, a mortgage is a legal contract secured on a property between you and your lender. If you don’t respect the contract terms, by not paying it on time, for example, the lender or bank can legally take your property. This leads to another important topic, which type of mortgage is ideal for you?


Understand the fixed and variable mortgage interest rates

If you want to buy a house but aren’t sure you can afford it, a mortgage calculator can be a helpful tool. This helps you figure out the amount for the down payment and decide which mortgage term and interest rate make more sense for you. Your bank or lender may offer a few different mortgage interest options, such as fixed, variable, and hybrid interest rates. 


Fixed interest rate

The name says it all. This option will have the same or a fixed interest rate for the entire mortgage term, the total length of time for you to repay your loan. These interest rates are usually higher and are ideal for those who prefer to know exactly what they’ll pay each month. With a fixed interest rate, your payments will stay the same for the entire term.


Variable interest rate

If the buyer opts for a variable interest rate mortgage, the amount paid for each installment can increase and decrease during the term. This is ideal for buyers who feel comfortable with fluctuating and lower interest rates than the fixed interest rate. Another benefit this option offers is the opportunity to adjust payments with a variable rate. As a result, the amount of each payment varies according to the rate.

Due to low rates implemented in 2020, homebuyers have preferred variable-rate mortgages. However, as we see interest rates going up, so will the mortgage payments. Therefore, moving forward, a fixed rate might be the safer option since payments remain the same for the duration of the mortgage term. 


Hybrid interest rate

The hybrid or combination mortgage rate has the best of both previous options. It allows the buyer to combine both fixed and variable interest rates. How? By setting a portion of your mortgage with a fixed interest rate, the buyer takes advantage of knowing the payment amount for a few installments; also, with the remaining portion of the mortgage calculated with a variable interest rate, the buyer benefits if rates fall.

Considering the Bank of Canada indicated that interest rates would be going up, borrowers with a variable rate mortgage rate should expect higher payments per installment, consequently negatively impacting their household finances. However, according to the Angus Reid Institute, “most Canadians are still on a fixed rate,” and their mortgages won’t be affected by higher interest rates.

Buying a house is a complex decision that involves making decisions that will impact your budget for years to come. Therefore, Canadians should look for tools and resources to help them make informed budget decisions. 


Choose the right mortgage 

Canada and the rest of the world are going through many political and economic uncertainties. Many investors are already predicting another recession coming our way. So, it’s a no-brainer that this could lead to interest rates going up in the near future. 

Canadians should be savvy about their budget and plan for multiple scenarios to secure a home for their loved ones. For new home buyers or those who already own a home but want to renew or refinance their mortgage, using a Mortgage Calculator can help project different financial scenarios. It allows users to customize their mortgage’s interest rate, down payment amount, the length of the mortgage term, and other features. In addition, this tool lets users calculate some incremental costs that most people forget to consider, such as home insurance, property tax, and condo fees. Finally, for those curious to know which mortgage interest rate you should opt for, taking this quiz crafted by financial specialists can help future homeowners decide between the fixed or variable rate options. 

To summarize, Canadians should pay attention to the continuous rise of interest rates in response to the country’s economic activity. With the COVID-19 pandemic, the Bank of Canada cut interest rates to encourage spending and boost the economy. However, with interest rates going up, Canadians should notice prices rising even more, which will reduce consumer and business spending that could result in an economic recession. 

The lower demand will carry on to the housing market, making it more difficult for buyers and sellers. One of the main reasons is that mortgage rates will increase, driving potential buyers away. However, financially savvy Canadians can take advantage of the lower home prices by organizing their finances and finding the best mortgage for their needs.


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