How to react to rising mortgage rates
Published on May 13, 2022
Interest rates, especially those related to mortgage financing, vary based on the economic context and financial market events. After rates stayed at historically low levels during the pandemic, increases are inevitable. Here are some explanations, the consequences for you and what you can do.
Why are rates going up?
Let's get right to the point. The Bank of Canada aims to achieve good economic growth, but its priority is to keep the inflation rate between 1% and 3%. Its main tool is the key interest rate. Financial institutions such as Desjardins use it to set interest rates for some of their own products.
When the economy is sluggish, central banks can lower their interest rates to facilitate access to financing and stimulate consumption. At the start of the pandemic, the Bank of Canada quickly dropped its key interest rate to a historic low of 0.25%.
On the other hand, when the price of real estate, gas and groceries gets out of hand, central banks get involved to limit the increase in the cost of living to between 1% and 3% per year. When the increase in the cost of living goes above this threshold, the key interest rate may be raised to slow economic activity. "High interest rates tend to encourage people to save and to borrow less," said Isabel Cousineau, Product Manager, Home Financing Product Management at Desjardins.
Anticipating the change in the key interest rate is complicated because it's influenced by many factors like market behaviour and geopolitical tensions. That's why Desjardins economists regularly adjust their forecasts and publish a large number of articles on economic and financial news.
What to do with rising mortgage rates?
First, it's important to stay calm. Rate increases are a cyclical pattern in the economy with the main purpose of slowing the increase in the cost of living.
For a number of years, mortgage applications have been subject to a stress test. The financial institution bases its assessment on a rate higher than that proposed. "Your ability to repay has already been checked in the context of a higher interest rate," explained Isabel. Unless your financial situation has changed significantly, you should already have enough leeway to manage higher mortgage payments.
Depending on the circumstances, here are some strategies to consider when rate increases are expected. Stay informed of current mortgage rates.
You're a first-time homebuyer
As soon as your plan to become a homeowner becomes serious, contact your financial institution to get mortgage pre-approval. The maximum amount will then be determined as well as the realistic amount you could borrow based on your income and down payment. Mortgage pre-approval also allows you to freeze your mortgage rate, which may ease your worries about potential increases during the set period. At Desjardins, this step usually allows you to set the rate for a 3-month period. Your advisor can tell you whether you qualify for the extended rate guarantee for up to 6 months.
You're already a homeowner
Rate increases don't normally affect the mortgage payment amount. However, some features apply based on the mortgage type.
A fixed rate remains the same for the entire term. You'll know the exact amount of your payments and what the balance of your loan will be at renewal. However, if you terminate your contract early (for example, by selling your property), you'll generally have to pay a penalty higher than that with a variable rate. Lastly, if interest rates are higher at renewal than they were at the start of your previous financing, you might expect an increase in payments.
Plan ahead, and take time to review your budget right away. A full budget exercise will help you rationalize your fears and see how much leeway you have. If you're able to do so now, contact your financial institution to increase your mortgage payments. This will help reduce the principal of the loan and the balance at renewal.
Generally speaking, when a variable rate fluctuates, the amount of your payments stays the same throughout your term. As long as it remains below the fixed rate offered to you at the time of signing, you should come out ahead. Payments are kept at the same amount during the term; changes in the variable rate affect the amount of principal repayment versus interest payment, which will determine the loan balance at the end of the term. When mortgage rates go up, you could end up with a higher balance than expected at the end of the term, and therefore at renewal. With higher rates than the previous term and a mortgage balance that is also higher than expected, you probably need to plan for higher payments to repay your new financing.
Talk to your advisor
It's not just a matter of dollars and cents; you also need to be comfortable with the mortgage you've chosen and how the payments fit into your budget. Feel free to make an appointment with your financial advisor to get personalized support that takes into account your profile, situation, plans and economic forecasts.
This partner content is presented by Desjardins.