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How a Rate Increase Affects Your Mortgage

What does a rate increase mean for your mortgage?

That depends on the type of mortgage you have.

If you have a fixed rate mortgage, then nothing changes. You will keep paying the same monthly amount that you’ve been paying since you began your term, and will continue to pay it until your term ends. However, when you do have to renew, you will be looking at higher mortgage rates.

If you have a variable rate mortgage, your monthly interest charges will go up equal to the increase in prime rate. The Bank of Canada usually increases the overnight rate (the key interest rate) in steps of 0.25 per cent and the current prime rate of 1.75 per cent. Keep in mind that this is the number for banks to lend to each other; the prime rate for consumers is 3.95 per cent. If the Bank of Canada raises the prime rate to 2.00 per cent, the banks’ prime rate will likely increase to 4.20 per cent.

Let’s say you have a variable mortgage at 2.75% as of July 9th, 2019. Your rate isn’t actually 2.75 per cent, but prime minus 1.20. If prime goes to 4.2 per cent, your rate would change to 3.00 per cent. You likely wouldn’t notice an increase in your monthly payments but you would notice a difference on your statement if you looked closely.

That difference would be the amounts going towards interest and principal. For every $100,000 in mortgage, a 0.25 per cent rate increase translates to $13 more per month going towards interest. A person with $500,000 remaining on their mortgage going from 2.75 to 3.00 per cent would see their interest charge in that first month go from $1,146 per month to $1,250 - $104 more. As time goes on, the amount going to principal increases and the amount going to interest decreases. You wouldn’t notice a change in your monthly budget, but you would feel the increase over time.

 

Will the interest rate go up on Wednesday?

With the next Bank of Canada interest rate announcement coming on Wednesday, July 10, you may be wondering if the rates are going to increase soon.

While no one knows with 100% certainty the direction rates will go, the overwhelming majority of economists surveyed (93%) expect the Bank to hold their overnight rate at 1.75%. It’s very likely that the Bank will decide to hold rates.

Looking to the future, many economists believe that rates will actually drop in or around October 2019. Their reasoning? A relatively weak economy that’s dependent on energy and the financial sector, both of which are underperforming. The US Federal Reserve is also considering rate cuts; US rate cuts are usually followed by Canadian rate cuts, eventually.

Basically everyone agrees, however, that rates won’t be going up anytime soon.

 

Should I go variable or fixed if rates are going down?

Remember what I said earlier: no one knows with 100% certainty the direction rates will go. While many believe that rates will go down, and for good reasons, the fact is something can happen between now and then that would require a rate increase or hold.

As early as late 2018, many expected rates to continue to rise well into 2019, but a slow economy had the Bank backpedal on their plans: low rates are used to help boost the economy. So it’s possible that some event happens, such as a sudden increase in the price of oil, which would make rate cuts redundant.

It’s best not to make your 5-year plan based on your predications of the economy, but rather your risk tolerance. Variable rates have historically worked out cheaper than fixed rates, but past performance is not an indicator of future results.

Not to mention, fixed rates are generally 1 per cent more expensive than variable rates, but the best 5-year fixed rates right now are actually cheaper than the best 5-year variable rates. And don’t forget about the ultra-low 2-year fixed rates being offered on the market too, from as low as 1.99%.

 


Chris Chris 07/16/2019
Canadian personal finance buff and all-around writing enthusiast, Chris loves breaking down complicated money ideas to show that they're really not so complex. 
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