With a week to go until the Bank of Canada’s widely anticipated July 13th announcement, expectation is solidifying among analysts that the central bank will hike its trend-setting Overnight Lending Rate by 0.75% -- an increase not seen since 1979.
Such a hefty increment would bring the baseline cost of borrowing from the current 1.5 to 2.25%, and boost consumer lenders’ Prime rates -- which variable mortgage and HELOC rates are based off -- to 4.45% from 3.75%.
The likelihood of a larger hike was sealed as the U.S. Federal Reserve made a 0.75% increase in their June 15th announcement, in response to a 40-year high inflation reading. Canada finds itself in a similar boat, with the CPI hitting 7.7% in May. Both central banks face a pressing mandate to reign inflation in with tighter monetary policy, leading to one of the steepest hiking cycles seen in recent memory.
A 0.75% hike will bring the Canadian interest rate environment to a level not seen since the mid-2000’s recession. That could cause a reckoning among borrowers carrying existing market facing debt, refinancing or renewing their rate, or applying for a new mortgage of any kind.
“What we are seeing right now is a rebalancing in the market,” says LowestRates.ca expert and licensed mortgage broker Leah Zlatkin. “The last time Canadians found themselves in a similar situation was during the recession in 2007. We saw rates rise to the most unprecedented levels since the early 80s, which meant we needed to budget accordingly. We’ll continue to see inflation rise throughout the rest of the year along with interest rates, but it’s unlikely that homeowners will find themselves in a situation where they cannot pay their mortgage if they budget accordingly.”
According to Zlatkin’s calculations, should the BoC hike by 0.75%, a homeowner with a variable mortgage rate of 2.7% on a home priced at $700,000 would see their rate jump to 3.45%, and their monthly mortgage payment to $3,038, an increase of $237.
HELOC holders -- who typically have a rate of prime plus 0.5% -- would see their rate increase from 4.2% today to 4.95%, with their monthly interest payment rising to $412.50 from $350.
However, Zlatkin points out, today’s OLR is still below 1.75%, where it sat pre-pandemic (it was then cut three times in rapid succession over the month of March 2020 in response to the shuttering economy. Given this, she says, most homeowners with existing variable-rate mortgages should be able to absorb the increases, with a little forward planning.
James Laird, COO of Ratehub.ca, says today’s variable-rate mortgage and HELOC holders are wise to calculate how their monthly payments will change, given there are still four more planned BoC announcements this calendar year.
“Anyone looking to purchase a home in the second half of 2022 should calculate how much mortgage they can qualify for using different stress test scenarios,” he says. “This is because the stress test continues to move higher as mortgage rates rise, which decreases affordability. A general rule to use is that someone qualifies for about 10 per cent less mortgage for every one per cent their stress test increases.”
The good news, he adds, is that Canadian bond markets are signalling the BoC may soon be done with its hiking cycle, bringing consumers relief and the chance to stabilize their finances.
“Bond yields are down by 60 basis points from their peak in mid-June. Easing bond yields should give consumers some comfort that the end of rate hikes might happen within the next couple of announcements,” he says.
“This group should also budget for further rate hikes this year, but should take some comfort that oversized rate hikes might be coming to an end, based on what the bond market is suggesting.”
However, he adds, a 75% hike will officially render today’s stress test qualifying rate of 5.25% meaningless; as all mortgage rates will be above 3.25%, all new borrowers will need to tack an extra 2% onto their rate to qualify.
The Impact on the Housing Market
It’s no secret that the scorching sales activity and price growth that ran unchecked over the course of the pandemic chilled after the BoC started its hiking cycle -- and buyers will continue to shy away from the market in the near term, says Rates.ca expert and mortgage broker Sung Lee.
“A 75-basis point increase will slow down purchases even more. We are already seeing people walking away from housing deals. The mindset has shifted,” he says.
“It’s a confusing time for many homeowners and would-be homeowners,” says Lee. “What is important to understand is that interest rates are cyclical. At some point in the next few years, we’ll see them come back down. In the meantime, they are still on the rise, and we simply need to plan the best we can. When the overnight rate goes up, the effects are felt immediately by some, such as variable rate mortgage and HELOC holders, but will be felt by others much later when they take on a new mortgage or renew. It’s crucial that homeowners understand their own mortgages and plan out their household budgets to accommodate any current and future changes in their mortgage payments.”
This trend is certainly reflected in the latest market data; the Toronto Regional Real Estate Board reported this week that sales in the region plunged 41% annually in June, while prices have dipped by nearly $200,000 from the peak observed in February. A recent analysis from TD Bank also anticipates that national home prices will have fallen peak-to-trough by 19% by the end of 2023, in response to rising rates.