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After flat and falling interest rates for many years, 2022 has been the year of rising interest rates. We saw prime rates go up for the first time in almost 4 years. Fixed rates are going up as well.
Let’s look at what rising interest rates means for consumer in the Canadian mortgage market.
There are two types of variable rate mortgages. Variable rate mortgages with a payment that changes as prime rate changes, and variable rate mortgages with a fixed payment.
If you have a variable rate mortgage with a payment that changes, it will mean that your payment will go as interest rates go up. This is a good thing because it helps you save on interest and keep up with your original mortgage payment schedule. However, this can also be a bad thing, because it forces you to pay a higher payment when your cash flow may already be pretty tight to begin with.
If you are feeling this way, you have the option of locking into a fixed rate. However, with a fixed rate, your payment is likely to go up even higher. That’s when you might consider a variable rate with a fixed payment. You’ll benefit from a lower payment and not have to worry about as many fluctuations in your mortgage payment.
And then there are HELOCs. If you’re making interest-only payments on your HELOC, your minimum payment will continue to increase as interest rates rise, putting further constraints on your household budget and cash flow.
It may still make sense to stick with a HELOC though. Even if you can lock into a fixed rate mortgage, your payment is likely to go up quite a bit, as you’ll be required to make principal and interest payments, instead of interest-only payments.
If you have a variable rate with a fixed payment, it could mean a longer repayment period for you. And here’s why.
Let’s say you signed up for your variable rate with a fixed payment mortgage at the beginning before rates started go up. If rates don’t come back down by the end of your mortgage term, your only options are to stretch out your amortization period or increase your payment.
If you don’t want to increase your payment, it will mean a longer repayment period. That means more interest over the life of your mortgage.
You can also face payment shock at renewal. Imagine having a 2.49% fixed mortgage rate and finding out that the renewal rate is 5.19%. That could mean an increase of 35% in your mortgage payment. Unless you’re willing to switch to a variable rate with lower payments, it will mean that you’ll need to figure out how to handle the increase. Kraft Dinner for breakfast, lunch and dinner, anyone?
If you’re in the real estate market for a home, higher interest rates mean qualifying to spend less on a home. That’s because of something called the mortgage stress test.
With the mortgage stress test you’re required to qualifying at the greater of the benchmark rate, or your mortgage rate plus 2%. With the benchmark at 5.25% and the recent 1% increase in interest rates by the Bank of Canada in July, both variable and fixed rate mortgage holders are being forced to qualify at their mortgage rate plus 2%. This could mean a reduction in home purchasing power of 10% or more.
In theory home prices should come down to compensate for the reduced purchase price, but that doesn’t always happen. That means not only could you qualify to spend less on a home, but your home purchasing power might also be eroded. Maybe instead of a townhouse, you might only be able to afford a condo now.
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