How Much Extra Do You Want to Pay the Bank for Your Mortgage?

By Rebecca Wissink

If you consume any amount of media you likely saw a lot of headlines about rising interest rates and the spring housing market recently. That’s because on January 26, 2022 the Bank of Canada (BoC) was announcing an interest rate decision. Most of these headlines were doom and gloom scenarios that have now disappeared given the BoC held its lending rate at 0.25%. The next scheduled date for the bank to announce a change is March 2, 2022. You can except headlines to ramp up again in the week or so prior to this announcement.

Why would the BoC change its overnight or “policy interest rate?” To meet the institution’s policy requirements to maintain inflation around 2%. In a nutshell, in response to the economic shocks of the COVID-19 pandemic shutdowns in March 2020, the bank reduced its rate to 0.25% to support growth in the economy where it has sat ever since. When money is cheap to borrow, people tend to spend more, thus boosting the economy, but this runs the risk of spurring inflation. In the fall of 2021 inflation hit its highest level in two decades. Currently the bank is forecasting inflation to run at 5% for the first half of the year due to a myriad of factors including: supply constraints; pent-up consumer demand due to COVID-19 lockdowns; and, higher food and gas prices. This forecast is an increase from only a few months ago when inflation was forecast to hit 3.7% this year. Alternatively, when debt becomes more expensive, people spend less, and this will curtail inflation. In a nutshell, any BoC rate changes will ripple throughout the entire banking industry, impacting the cost of your mortgage. Banks are businesses, so when the BoC raises its lending rate,banks raise their rate by the same amount. The Bank anticipates the inflation rate will ease to about 3% by the end of the year. This claim suggests, and the media speculates, we are in for roughly one year of interest rate increases.

A November 2021 Financial Post article suggests that beginning in March 2022, the BoC will raise interest rates six times. On February 7, 2022, Christopher Alexander, the president of RE/MAX Canada, reported that once rates start to rise, “it’s going to have a gradual effect” that will “take the steam out of the market.” In short, the frenzied activity that we have seen in Canada’s housing market the last year might settle down, despite a continuing lack of supply. However, between now and the first hike in interest rates, analysts expect the panic buying to continue, if not escalate, given buyers know rate hikes are coming. Change also isn’t likely to occur with the initial rate increase, argues mortgage expert Rob McLister. Another real estate specialist believes it will take three to four rate hikes for buyers to respond and the market to slow down. Meaning it could be the end of 2022 before any BoC changes impact the real estate market as a whole.

Let’s look at one actual listing in Calgary, a city Christopher Alexander says is having a “huge resurgence in attracting people from outside the province.” Table 1 below shows the cost of borrowing at various hypothetical points over the next year which establishes the real-world costs of increasing interest rates. I’m going to make some assumptions about the buyers in this scenario to simplify the math. This is a professionally established couple that has sold their home in Toronto and cleared 1 million dollars from that sale. They will now use that amount as a down payment on this home. The couple is paying the list price of $1,785,000. The couple avoids Canada Mortgage and Housing Corporation (CMHC) fees because they are putting down more than 20%. This couple does not qualify for any first-time home buyer’s assistance and their income assures they can pass the stress-test. As our couple is in their mid-forties, they are opting to repay their mortgage over 20-years (the amortization period) so that they are clear of payments by retirement. Lastly, the couple is opting for a five-year fixed-rate term.

 Table 1. The Cost of Borrowing $785,000 at Various Interest Rates

The difference between 3 and 4.25% borrowing costs on this mortgage is a difference of $499 per month, or $5,988 per year. Over a 20-year mortgage, a potential 1.25% increase in interest rates on $785,000 amounts to an additional $120,597 paid to the bank. Hence, the media reported scurry of housing activity to get ahead of these increasing interest rates and purchase a home sooner.If you’ve been thinking about purchasing a home and want to get ahead of these forecasted additional costs, speak to an experienced Ross Pavl ELITE Real Estate Group Realtor®today.

Some notes - As of February 8, 2022, TD Bank was offering a 5-year fixed rate mortgage at 2.94% while the Bank of Montreal was advertising 2.99%. In contrast, CIBC and Royal Bank are over 3%, while Scotiabank is advertising 4.79%. I’ve averaged these rates to 3% as the starting rate in the table above. Further, the hypothetical date of purchase in Table 1 follows shortly after the eight fixed dates in the calendar year that the BoC announces its overnight rate. Meaning the home is purchased after a rate increase has taken effect. Finally, a clarification regarding CMHC mortgage insurance - it is only available when the purchase price is below $1,000,000.

Image via creative commons courtesy of BTC Trinkets .com

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