Inflation, rising interest rates, increasing housing prices – it can all be overwhelming! What could possibly be next?! Let’s break it down and talk about how rising interest rates correlate to homeownership.
Let’s get down to the basics…
Rising interest rates represent an increase in the cost of borrowing. Increasing interest rates is a tactic utilized by the government and centralized banks to help “curb” inflation and the rising cost of goods. How? By raising interest rates, individuals are likely to spend less because the cost of borrowing increases. With fewer people borrowing and spending less in the economy, the price of goods deflates to stimulate economic activity and return to a more “balanced normal.”
Economics can be kind of confusing. Let’s break it down a bit better.
Think of inflation and rising interest like going to the movies. Inflation represents the movies, interest rates represent the movie tickets, and the movie theatre represents the centralized system. Initially, you could go see a movie for $10. Today, the “hype” (inflation) for going to the movies keeps increasing, therefore the theatres are selling out, people are lining up outside the doors and they are having trouble keeping up with the demand. To help curb the demand they decide to increase the cost of tickets to $20. Resultingly, fewer people are interested in attending movies and the movie theatre demand is decreasing to a more “balanced normal” to accommodate and safely seat moviegoers. This is the relationship between inflation and rising interest rates.
How much have inflation and interest rates increased?
As of May 2022, consumer inflation has increased to 7.7% (up from 6.8% in April 2022) from May. The last time inflation rose so significantly was in January 1983. For reference, the Bank of Canada targets a 1% to 3% inflation control annually.
As of June 1, 2022, the Bank of Canada has increased interest rates by 1.5% in 2022. Correspondingly, the Prime Rate increased to 3.7% as of June 1, 2022.
: A Prime Rate is the “ideal” rate for preferred customers with high credit ratings. High credit ratings indicate less credit risk towards lending to these customers.
How often do interest rate announcements occur in Canada?
In Canada, there are eight interest rate announcements per year. Dates for 2022 include:
- Wednesday, January 26
- Wednesday, March 2
- Wednesday, April 13
- Wednesday, June 1
- Wednesday, July 13
- Wednesday, September 7
- Wednesday, October 26
- Wednesday, December 7
Notably, these announcements can include an increase or decrease in interest rates, or they may announce no change at all.
How will rising interest rates affect new homeowners?
As we talked about, rising interest rates mean higher borrowing costs for you, the buyer. Higher costs = less demand for purchasing. Resultingly, real estate markets are likely (not always) to enter a “Buyer’s Market”. Buyer’s Markets mean that home buyers have greater leverage to negotiate prices as there is a surplus of homes for sale. This can be positive as buyer power is greater, but it is counterbalanced by the high costs of borrowing.
Sellers > Buyers = Buyer’s Market
Buyers > Sellers = Seller’s Market
Sellers = Buyers = Balanced Market
In a seller’s market, there are fewer homes than there are buyers. As a result, sellers have the opportunity to slightly increase prices as a way to profit from the high demand. In a buyer’s market, there are more homes than there is demand. As a result, buyers have more negotiating power to decrease the listing price and get a better deal. Think of buyer’s and seller’s markets like winter jacket shopping. In the fall/winter, retailers can charge the full price for jackets as there is a high demand to stay warm during the winter – this is a seller’s market. In the spring/summer, retailers will choose to discount the winter jackets to minimize inventory resulting in the buyers getting a better deal – this is a buyer’s market.
Additionally, rising interest rates will affect new homeowners, as they will have to partake in the Canadian mortgage stress test. As of June 1, 2022, the stress test qualifying rate is 5.25% (up from 4.79%). This means that the buyer needs to be able to pay a 5.25% interest rate (+ principal) to qualify for a mortgage.
How will rising interest rates affect existing homeowners?
Rising interest rates will affect existing homeowners with a variable rate mortgage. Higher interest rates will increase your period payments with a variable rate mortgage.
Variable rate mortgages are beneficial when interest rates are expected to decrease. Fixed-rate mortgages are beneficial when interest rates are expected to increase, allowing you to lock in a lower interest rate. Fixed-rate mortgages make it easier for personal budgeting as your monthly
payments will remain the same with a fixed-rate mortgage but will fluctuate with a variable-rate mortgage.
Additionally, planning for the future of your mortgage is important! If your mortgage term is nearing expiry and interest rates are rising (and expected to continue rising), consider a short-term fixed mortgage. This will allow you to lock in a lower interest rate and reassess the market sooner than with a long-term mortgage.
For example, say you locked in a fixed-term mortgage for 5 years during a high-interest rate period. In year 3, interest rates decrease substantially. However, you will need to continue paying the higher interest rates until term expiry to avoid paying an early refinancing penalty.
How Can a Mortgage Broker Help You When Interest Rates are Rising?
Mortgage brokers are in place to help you, the buyer, access financing and equity from an array of potential lenders to refinance or renew mortgages, outline options, and best practices to support your financial well-being, and simplify the lending process along the way. Mortgage Brokers work with you, not against you, to secure the best option for your financial goals!
A 2016 study titled, “The Rise of Mortgage Finance Companies in Canada: Benefits and Vulnerabilities,” published by the Bank of Canada highlights the importance of hiring a mortgage broker. Individuals who hire a Mortgage Broker typically have access to a larger pool of potential lenders – both traditional and branchless lenders who operate exclusively in the broker channel. Resultingly, the buyer’s bargaining power is greater with a Mortgage Broker than searching on their own. Additionally, Mortgage Brokers help reduce the personal time and cost of obtaining multiple quotes from lenders.
As interest rates rise and economic conditions may be uncertain, consider reaching out to a Mortgage Broker to reassess your financial needs. They can chat about term lengths, payment options, refinancing and assessing available credit, and SO MUCH MORE!
During times of high uncertainty and rising interest rates (like we’ve never seen before), Mortgage Brokers are in place to secure you the best rate possible, assess the market, and work with you to achieve your financial goals.
Reach out to our team today and let’s start chatting about your options!