There is a lot of negative talk around the Bank of Canada’s interest rate increase, but I think it’s good thing.
Higher rates suggest our economy is strong enough to withstand a return to a more normal rate environment. Despite global trade tensions and unresolved NAFTA negotiations, the TSX Composite has performed well. In fact, it has hit record highs in recent days, while at the same time unemployment levels are low and inflation is creeping closer to two-per-cent target levels.
Sure, there is concern about the debt levels of Canadians, but Janine White, VP of marketplaces at RateSupermarket.ca points out a rate hike would increase the interest Canadians pay on financial products like a line of credit or variable-rate mortgage.
“In the long run, it would make borrowing and carrying debt more expensive across the board,” she said. “However, as Canadians are getting better at managing their debts, it could possibly lead to normalizing debt levels."
And that would a good thing.
While the economy may be strong enough to withstand a rate increase, what about your household balance sheet? This isn't just about higher variable rate mortgage payments — if you are carrying any sort or variable rate debt, you will see an increase in your monthly payments. You need to know your numbers and understand the financial impact on your family. A 25-basis-point rate hike means nothing until you translate that into actual dollars.
This isn't the first time we have had to undergo a family financial stress test. This is the fourth rate increase from the Bank of Canada in 12 months. And what a difference a year makes.
According to Ratehub.ca, if you had a mortgage of $400,000 amortized over 25 years, with a five-year variable rate of 2.5 per cent, your monthly mortgage payment would have started out at $1,792. After Wednesday’s rate increase, the payment goes to $1,997 – or in other words, a payment increase of $205 per month. From July 2017 to July 2018, you would have paid an additional $1,627 in total interest.
"Rates can become volatile after a Bank of Canada announcement, depending on the announcement's content, so anyone who requires a mortgage should act quickly to lock in a rate,” said James Laird, co-founder of Ratehub.ca and President of CanWise Financial.
Variable rate mortgages have increased in popularity over the years; some will argue they are still the place to be. If further rate increases are manageable, by all means stick with the plan. However, why not take it a step further and hedge your bets?
I reached out to Allan Tran, business development manager at Meridian Credit Union, and asked him for a strategy for those not wanting to lock into a fixed mortgage. Here's what he recommends:
- Look for ways to increase your regular payment now. When thinking about changing your mortgage, see if you can make a higher payment. For example, if you are taking on a variable rate at 2.45 per cent, on $100,000, the mortgage payment would be $445.48 monthly (principal and interest) over a 25-year amortization.
- Let’s say you want the rate because it is lower than the five-year fixed rate ( 3.49 per cent). If you went fixed, your monthly mortgage payment would be $498.74 over the same 25-year amortization. If you take the variable rate, increase your payment from $445.48 to $498.74. You actually decrease your amortization from 25 years to 24 years. This means something as simple as increasing your mortgage payment by $53.26 per month can knock a year off of your amortization and you can own your home sooner.
- If you have any revolving products (LOC, HELOC, Mortgage variable, Business LOC) know how much “stress” you can take with interest rate increases. Could you weather a one-per-cent increase, two-per-cent-increase, five per cent increase?
Bottom line is if the economy continues to pick up and you can find ways to pay down that mortgage –and if a variable rate mortgage is your preferred choice – be prepared for additional rate hikes in the next 12 months. However, a fixed rate mortgage should be a serious consideration if you are living close to the margin.