Rising interest rates: An action plan for Canadians
22 February, 2019 / by Glenn Carter
For years the Bank of Canada has been warning about the possibility of higher interest rates, but those pleas have largely fell on deaf ears. In July 2017 everything changed when our central bank put its money where its mouth is and raised interest rates for the first time in seven years.
Mind you it was only a 25 basis point increase, but the increase signaled a trend towards rising interest rates. The Bank of Canada has since increased interest rates five times.
Although no one is absolutely sure if more rises are in the future, economic and political uncertainty are making consumers nervous. It never hurts to prepare yourself!
A recap of the rise in interest rates
After seven years of falling interest rates or rates remaining the same, the Bank of Canada increased the overnight lending rate by 25 basis points from 0.50% to 0.75% in July 2017.
This wasn’t a one-off interest rate increase. Our central bank has increased interest rates by 125 basis points since July 2017, the last such increase coming in October 2018. The overnight lending rate currently sits at 1.75 percent, with further rate increases expected in 2019.
The overnight lending rate is important because it directly impacts what Canadians pay to borrow money from lenders. Any increase in the overnight lending rate means that the banks are likely to follow by matching an increase in prime rate, the rate offered to the bank’s most creditworthy clients.
Prime rate affects how much you pay on any of your debt tied to prime. This includes variable rate mortgages and HELOCs (home equity lines of credit). An increase in your cost of borrowing can mean that a property that used to be in a positive cash flow position could find itself in a negative cash flow position.
Fixed mortgage rates, driven by Canada bond yields, have been on the rise. This is resulting in a higher cost of borrowing for those with fixed mortgages coming up for renewal in the coming months.
The mortgage stress test
At the beginning of 2018, we also saw the introduction of yet another major new mortgage rule: the mortgage stress test. As a borrower, you must now prove that you can afford the greater of either 2% above your qualifying rate, or the five-year Bank of Canada benchmark rate.
The mortgage stress test coupled with higher interest rates is forcing some borrowing who once qualified A lenders to seek out mortgage financing from alternative lenders. This has resulted in the alternative space seeing strong growth in the last year.
Switching lenders and refinancing your mortgage
If you’re considering switching lenders or refinancing your mortgage, you may be wondering how higher interest rates could affect you. Due to the mortgage stress test and the fact that you have to qualify at a mortgage rate 2% higher, if your financial situation changed from when you first took out your mortgage, you may have difficulties switching lenders or refinancing your mortgage.
You may find that you’re forced to stay put at your current lender, when you otherwise may have switched lenders prior to the stress test being introduced. As mentioned earlier, this is forcing more people into the private space who otherwise may have qualified with A lenders.
But all hope isn’t lost, and it’s best to chat with your trusted mortgage professional about your options if you feel stuck with your current lender.
Protecting yourself from higher interest rates
Looking to protect yourself from rising interest rates? Here are four good ways to be proactive against higher interest rates.
Pay your mortgage as if rates are higher: If you’re in a variable rate mortgage and you’re concerned about higher rates, you can stress test your own finances and pay your mortgage as if rates are already 2% higher. You’ll save on your mortgage interest and you’ll be used to the higher cash requirement when higher interest rates do arrive.
Consider locking into a fixed rate mortgage: Although nobody has a crystal ball, if you’re someone who’s risk-adverse and you feel there are other interest rate increases on the horizon sooner rather than later and you have a variable rate mortgage, you might consider locking into a fixed rate mortgage. Although you’ll likely pay a higher interest rate when you lock it, you won’t have to worry about higher interest rates for the duration of your mortgage term. That peace of mind can be worth paying a premium for some.
Turning your HELOC balance into a fixed rate mortgage: Do you have a large HELOC balance with no plans to draw on it for the foreseeable future? Then you might consider turning your HELOC into a fixed rate mortgage. Not only are you likely to save interest (fixed mortgage rates are generally lower than HELOC rates), you won’t have to worry about rate increases affecting your cash flow during the term of your fixed mortgage.
Consolidate high interest consumer debt: Canadians carrying unsecured debt loads should look to exercise dormant property equity to reduce rates and lock in before rates rise. Don’t forget, as rates rise, it’s not just your mortgage that is affected.
There’s no need to worry about higher interest rates. As long as you have a game plan in place and you stick to it, you should be fine when higher rates do arrive. Be sure to consult a professional mortgage advisor who can guide you in the right direction depending on your current financial situation.