Everything you need to know about the most recent prime rate increase

 

The Prime Rate has gone up 1.00% as of July 13, 2022. This is the single largest Prime rate hike since 1998. This does not mean your payments have doubled (read more about the changes and how it effects you below)

 

How does this affect my mortgage?

This rate increase will affect variable rate mortgage holders, and those who have a Home Equity Line of Credit. If you currently have a variable rate mortgage, or a Home Equity Line of Credit, you can expect an increase in the amount of interest you will pay.

If you are currently in a fixed rate mortgage, the rate increase will have no effect on your payments.

I’m in a variable rate mortgage where my payments change when Prime moves, how does this affect me?

With a rate increase of 1.00%, as an approximate calculation; for every $100,000 you've borrowed, you will see an increase of roughly $54 per month in interest.

 
 

I’m in a STATIC variable rate mortgage where my payments do not change when Prime moves, how does this affect me?

If you are in a static variable rate mortgage, your payments will not change with the most recent increase in Prime. However, many individuals took out a static variable rate mortgage over the past 1-2 years and have large discounts to Prime. With static variable mortgage, there is what’s called a “trigger point” (or “trigger rate”), which means once you reach the trigger point none of your mortgage payment is going towards principal and all of your mortgage payment is going towards interest. If you reach the trigger point, your lender may reach out to you to ask you to increase your payment, convert to a fixed rate mortgage, or to make a lump sum payment to bring your mortgage balance below your original borrowing amount.

You can find your trigger point (or trigger rate) details on your Mortgage Loan agreement that you signed at your lawyer or notaries office. 

To avoid potentially reaching the trigger point (or trigger rate), I suggest reviewing your budget and, if there’s room in your budget, to increase your payments to account for the extra interest.

 

Are more rate hikes on the horizon?

No one has a crystal ball and can accurately predict when Prime will move. With that being said, most economists in Canada are predicting at least 1 more rate hike by the end of this year. Our chief economist Dr. Sherry Cooper is predicting that Prime will increase by another 0.75% by the end of this year. Her blog post is very informative which you can find a link to below.

Economic Insights with Dr. Sherry Cooper

These large rate hikes are mostly due to the Government attempting to curb inflation. Historically speaking when we are in a rising rate environment due to inflation, once inflation is under control we will see Prime begin to decrease. Most economists are predicting inflation will be under control early next year, which means Prime will likely begin it’s downward trend at some point next year. This high rate environment we are currently in will not last forever.

 

What about fixed rate mortgages?

Fixed rate mortgages are tied to bond yields. Very recently the Canadian 5 year bond yield has begun moving downward. This means that fixed rate mortgages will likely follow suit on a downward trend over the coming weeks.

 

Is it time to lock in if you are in a variable rate mortgage?

With such a drastic increase to the Prime lending rate, many individuals are questioning whether now is the right time is to lock into a fixed rate mortgage. Before making this decision let’s look at some numbers.

Fixed rates have already increased across the board, with the largest 5 banks currently hovering around 5.34% - 5.59% for a new 5-year fixed mortgage. Variable rates are still lower and are currently hovering around 4.30% - 4.50% for a new 5-year variable mortgage depending on the lender. Most mortgage holders who took out a variable rate mortgage within the past two years will have a current rate between 3.90% - 4.30%.

However, it’s important to consider that Canadians with Variable Rate Mortgages have been the big winners and have paid significantly less overall interest for over a decade. Historically, those who take variable rate mortgages and stick with it save thousands more interest over their term compared to fixed rate mortgages.

Inevitably rates will rise. This also means that inevitably rates will come back down again. If you lock into a fixed rate now, you are committing to a higher rate for the duration of your term. When rates start to come back down again, you will see no benefit if you are locked into a fixed rate.

If you decide to lock into a fixed rate mortgage and rates start to come back down again, you could investigate refinancing to take advantage of a lower rate, however there will be a rather large pre-payment penalty to refinance your fixed rate mortgage, which brings us to our next topic of discussion, pre-payment penalties.

 

Pre-payment Penalties

Many people overlook this portion of their mortgage, as they are only concerned about getting the best interest rate.

Statistically speaking, 6 out of 10 Canadians will break their mortgage at an average of 3 years into their 5 year term. There are many reasons why people break their mortgage. Divorce, spousal separation, employment change, health issues, downsizing or upsizing, a variety of social issues, or desirability to leverage equity in their property. When you break your mortgage, you trigger a prepayment penalty.

The example above is based on a $500,000 mortgage.

Variable rate mortgage typically have a penalty of 3 months worth of interest to break the mortgage. On a $500,000 mortgage, this would equal a roughly $5,000 penalty.

Fixed rate mortgage penalties are calculated using what we call an Interest-rate differential. This is a rather complex calculation which varies per lender, but as a general rule of thumb it works out to around 3% of the mortgage balance. On a $500,000 mortgage this penalty would work out to roughly $15,000.

 

Other Information to consider on Fixed vs Variable mortgages

Fixed Rate: Your interest rate and payments stay the same throughout the length of the term.

Variable Rate: Just like it sounds – the interest rate is predicted by the Bank of Canada’s prime lending rate and can change up to 8 times a year. The variable portion is guaranteed by the lender to be either a premium or discount of the prime interest rate.

The interest rate cannot, and will not, randomly change without notice. There are 8 Bank of Canada meetings per year to determine whether to increase, decrease, or keep the prime rate the same.

The interest rate or your payments will not ‘double overnight’. Generally the prime rate will not move more than 0.25% at any of these Bank of Canada meetings. The most recent rate increase of 1.00% has not happened since 1998 and is due to the current status of our economy.

 
 

Now that we’ve deep dived into the differences between fixed and variable rate mortgages, it's always best to consult with a mortgage specialist before you decide if it’s the right time to lock in. I am always happy to go through all the options available to you, give me a call anytime or schedule a consultation through the button below.

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