On June 1st the Bank of Canada (BoC) increased the Prime Rate 1% to 1.5%, an increase of 0.50% that was widely anticipated by the markets. For consumer banks and mortgage lenders, this means they will be raising their consumer Prime rates from 3.2% up to 3.7% on all variable and adjustable rate mortgages as well as Lines of Credit.
The reason is simple; the BoC is trying to slow inflation that has been creeping up over the last few months. By increasing the Prime Rate, the BoC intends to slow down borrowing activity, which will lead to businesses and people spending less money, reducing demand on products and services and therefore reducing (or at least slowing the increasing of) prices.
We expected the BoC to increase the Prime Rate by 0.5% at this meeting, and we anticipate a few more increases this year and next year. Right now, our best guess is about another 0.5% increase to the Prime rate in 2022 and another 0.5%-1% increase over 2023 (probably in smaller 0.25% rate increases happening every 3-6 months or so).
If you are one of our clients who started a variable rate mortgage in the last 12 months, your mortgage rate is likely somewhere in the range of Prime – 1% (give or take a bit depending on when you got your mortgage). This means your effective rate of interest is going to become about 2.7% for your mortgage payments moving forward.
While it isn’t fun to hear that your mortgage interest rate is going up, remember that we will have discussed with you that you should expect Prime to be increasing over the next few years and we factored these increases into the overall decision making. That said, we certainly were not expecting rates to increase so rapidly. Remember that you’ve been saving a bunch of money having a super low interest rate leading up to these current rate increases.
If you are considering locking into a fixed rate at this point, you will convert to a rate of roughly 4.5% (give or take 0.25% depending on your lender). This will immediately cause your monthly payments to jump up substantially; for example using a mortgage of $300,000 and a 25 year amortization:
- if you have a variable rate, currently with an new effective rate of 2.7% as of the June 1st rate increase, your monthly payments would be $1,376.27
- If you convert to a fixed rate mortgage at 4.5%, your monthly payments will go up to $1,660.42
While there is definitely a benefit to having security and being able to plan and budget for the future, paying an extra $300 per month immediately is a heavy price to pay for locking in.
If you are comfortable with planning for future rate increases and have the budget to be able to afford higher payments if/when they occur, staying variable will likely mean seeing your monthly payments slowly increase over the next 18 months before they eventually reach the same amount as locking into a fixed rate would do immediately.
Of course, in staying with a variable rate you have the potential risk that your effective interest rate could continue increasing past 4.5% (that would mean prime would have to increase past 5.5% in our example of a Prime – 1% variable mortgage). But on the other hand, you also have the potential benefit that if inflation cools or our economy enters a recession and Prime stops increasing in 2023, then your variable rate will not go as high and could even start coming back down. By locking into a fixed rate, you would have to continue paying the 4.5% interest rate while those who stayed in variable rate mortgages see their payments decreasing.
The biggest factors contributing to uncertainty about the future of inflation and the Canadian economy are:
- the ongoing supply chain issues caused by the COVID pandemic (which is reducing the supply of goods coming to markets, driving up prices)
- the war Russia is waging on Ukraine (which is causing huge increases to the prices of oil and natural gas around the world, and is now beginning to drive up food prices with Ukraine now expected to be unable to grow and export its usual harvest of grains and cereals to Europe and the Middle East)
- Whether a new COVID variant could cause new lockdowns around the world
The sooner the first 2 items are resolved or mitigated, the sooner inflation will start dropping back to usual levels.
On the other hand, since the Canadian economy is largely supported by exports of natural resources and agricultural products, we are already seeing (and can expect to continue seeing) some specific benefits that may help mitigate our downside effects from Russia’s invasion of Ukraine. The substantial increase in global oil and natural gas prices is starting to have a positive impact; first in Alberta which is seeing a boom in oilfield revenues and now a resurgence in property prices as people start moving back to Edmonton and Calgary; and likely next for our natural gas industry as LNG exports increase. So while we are all going to feel the pain of higher gasoline prices at the pump and larger utility bills for our natural gas heat, these sectors of the economy are going to benefit substantially over the next few years and contribute more jobs and tax revenues to our economy. As well, while our grocery bills will be larger and restaurant prices will increase do to lack of grain supplies from Ukraine in the short term, our agricultural industry should begin benefitting from the rising food prices globally, which will bring new jobs and revenues to farming communities that are able to sell their goods at higher prices and increase their production to meet the rising demand.
These are just a few of many uncertain factors confounding everyone’s economic models and predictions about the future. It is a very complex situation and no one knows for sure what will happen. The best you can do is make your decisions based on the best information available, and weighing your personal priorities, family budget and risk tolerance levels. If you have any specific questions about your mortgage and need help modeling what the different possibilities look like for locking in or staying variable, we are here for you.