On April 13th, the Bank of Canada announced it was raising the overnight rate by 0.50% to 1.00% to address the increasing costs of goods within Canada. This increase is reflected in the prime rate offered by banks, with the current bank prime rate listed at 3.20%. This is the second increase in 2022 after a 0.25% increase earlier in March.
The Bank of Canada uses interest rates as a monetary tool to manage inflationary pressures on an ongoing basis. As costs of goods increase, presumably, a rise in interest rates will see consumers shift their habits to focus on debt repayment rather than spending. This is intended to reduce the excess cash in the system and reduce demand on consumable goods.
Inflation refers to an increase in prices over time, which subsequently leads to a decline in the purchasing power of money. The most common way to measure inflation is through the Consumer Price Index (CPI), which uses a standardized basket of goods and services to track prices over time. According to Statistics Canada, inflation reached 3.4% in 2021. In March, Canadian CPI increased 6.7% year over year.
Many Canadians have experienced the effects of inflation over the last few years and while this rate increase is intended to help alleviate much of the rising pressure on goods, it is also widely expected that rates will continue their upward trajectory as we move into the second half of this year.
We have received a number of questions asking about how these rate changes will impact current strategies, and wanted to provide some clarity around some common inquiries.
What does this mean for my Mortgage?
If you have a fixed-rate mortgage, there will be no change to your payment or interest rate until the end of your term.
If you have a variable rate mortgage, your interest rate will increase. Variable mortgages are offered based on a discount on the prime rate, so while the discount will remain the same as the prime rate increases your total mortgage interest rate will change accordingly. For example, a prime -0.90% variable mortgage will have increased from 1.55% in January when prime rate was 2.45%, up to 2.30% with this second rate increase. The impact on your mortgage will differ depending on whether you have a fixed-payment variable mortgage or an adjustable rate mortgage.
If you have a fixed-payment variable mortgage, you will likely not see any change to your payment; however, a larger proportion of each payment will be allocated to interest which will lengthen the overall amortization of your mortgage. If rates continue to increase you may see an increase to your payment if the minimum interest amount is not met, however, this is rare. Details on the minimum interest amount would be detailed in the terms of your mortgage.
If you have an adjustable-payment variable mortgage, you may have noticed a change to your monthly payment and will see further adjustments with every rate change for the duration of your mortgage term.
Not all lenders offer fixed-payment variable mortgages. The following lenders, those who offer adjustable-payment mortgages, will see mortgage payments that adjust with interest rates (note that this is not an exhaustive list):
- Equitable Bank
- MCAP
- RFA MortgageTangerine
- National Bank
- Home Trust
- First National
As you can see from the above list, none of Canada’s big 5 banks are represented as offering adjustable-payment mortgages. Scotiabank, however, does offer both options.
If you are concerned about the potential rise in interest rates, some mortgages provide the option to lock-in your mortgage rate for the remaining term of your mortgage. If you would like to explore this possibility, you can confirm the current lock-in rate with your lender. It should be noted, however, that these lock-in rates have further rate increases priced into their offerings and can be seen as a way of banks capitalizing on anxiety regarding future rate increases.
Another option that we feel is more effective in minimizing rising rate exposure for a mortgage, is to determine your lock-in rate, and choose to increase your payments based on that higher rate. In this respect, you would have the benefit of putting further payments towards principal at a much lower variable interest rate. These extra payment amounts can act as a shock absorber to future rate increases and help to keep you on track towards your overall mortgage goals.
What does this mean for my other debts?
If you have a home equity line of credit or any other personal line of credit, you will see an increase in your borrowing rate. With prime rate increasing to 3.20% this will result in an immediate change to your lending rate. For provinces that are currently charging interest on student loans, the increase will also be immediate.
While rates are still below pre-covid levels, consumers should be aware of the upcoming changes and be prepared to adjust household cashflow accordingly. With rates at historical lows over the last few years, there has been little incentive to target debt in favor of deploying excess cash towards investments and other consumables. As intended, these rate increases are meant to change consumer habits and as rates continue to rise, we expect to see a shift in how we prioritize debt in long-term planning strategies.
Impacts on planning
If you have any questions about how increasing interest rates will impact your specific situation, please feel free to reach out to your TPC Financial Group advisor or visit our website to set up a meeting.
We will be providing a follow-up newsletter in the coming days to detail other strategies to keep more of what you earn and prepare yourselves for a rising interest rate environment.