The Bank of Canada (BoC) is next meeting on Jul 13, 2022 and at the moment it looks likely that it will raise the Prime interest rate by another 0.5% to 0.75%.  A 0.75% Prime rate increase will mean that people with variable rate mortgages will see their payments increase by $40/month for every $100,000 of mortgage debt (so a $400,000 mortgage would see a payment increase of $160/month).

The latest employment data released last week (covering May 2022 numbers) shows that the Canadian labour market gained 40k positions last month, leading to a small decrease of 0.1% in the unemployment rate (down to 5.1%). This is a very low unemployment rate for Canada and it signals that businesses are experiencing increasing demand for their products and services and they are urgently hiring more people. After 2 years of pandemic lockdowns and stay-at-home orders, it seems that there’s substantial pent-up demand for vacations, restaurant dining and other in-person experiences – many people saved money over the last 2 years and they are now keen to spend it.

While this is good news for job-seekers and existing workers, since it means employers are offering higher wages and perks to hire new employees and keep existing staff, it also means businesses will pass these higher payroll costs on to customers by further increasing prices. These higher labour costs will be coming on top of the already surging energy costs (oil and gas prices going up because of Russia’s invasion of Ukraine), higher shipping costs (caused by the pandemic disruptions and increasing fuel costs) and rising food commodity costs (driven by the war in Ukraine) which have already been pushing prices up for the last few months. While the BoC can’t directly influence the disruptions caused by the pandemic or the Russian invasion, it will likely use another big Prime rate increase to try and reduce everyone’s spending and cool down the job-market inflation as much as possible. 

For this reason, we expect inflation to continue to be a problem for the BoC throughout the summer as people indulge themselves in ‘return to normal’ activities. There will be a turning point eventually though, when the extra money saved over the last 2 years is gone and the higher costs for a restaurant dinner  or vacation start to look daunting. Going into the fall, we hope to start seeing some real impact of the rate increases, causing a pullback in consumer spending and a cooling of the job market to go along with dropping temperatures. At that point, prices should begin to stabilize and the BoC can pause the ‘catch up’ rate hikes and develop a more measured and considered plan for 2023.

Impact on Mortgages and Real Estate

In the meantime though, the rising inflation and increasing Prime lending rate are fueling higher mortgage rates for both fixed and variable rate customers, which we are now seeing have a real impact on housing markets across the country. Year to date, the number of real estate transactions in BC is down 35% compared to 2021. Higher mortgage rates reduce the amount of mortgage for which people can qualify, which means there are less people able to buy any given property up for sale. Prices have not dropped yet in BC, but they have in Ontario and it’s likely we’ll see BC follow suit in the second half of this year as sellers are forced to reduce their expectations and meet buyers at the prices they can afford.

Potential Trouble with Home Equity Lines of Credit

If home values do start to slide substantially, one other factor to be aware of is that Home Equity Lines of Credit (HELOCs) might start to get cut. If you have a HELOC now and you are expecting to be able to rely on borrowing from that to get through the next few years, this could become a big and unexpected problem.

Technically, a HELOC is a demand loan, which means a bank has temporarily approved a maximum borrowing limit and you can borrow up to that amount.  However, it also means the bank can decide to reduce the maximum limit at any time, based on its internal assessment of risk. For example, if you have a HELOC with a $200,000 limit and are currently borrowing $50,000, but the bank is worried that your house value is declining and the economy is going into a recession, the bank can arbitrarily decide to reduce your maximum borrowing amount down in order to reduce their risk exposure. In this example, you might receive a letter in the mail informing you that your HELOC limit has been reduced to $75,000 (or even to the current balance of $50,000) and would not have any say or recourse in the matter except to switch to a new lender (meaning new qualification and potentially paying penalties and then higher interest rates for the new mortgage). The lender can also change your interest rate on a HELOC (the discount or surcharge added to Prime), so you might have a HELOC today with a rate of Prime + 0.5% but receive a letter informing you that the rate will change to Prime +1.5% next month. Again, you would have no recourse except to pay back the loan or try to switch to a new lender if you can qualify.

These drawbacks of a HELOC product often surprise people, who assume the limit and interest rate of their HELOC is secured by a contract. The reality is that if you want to guarantee yourself access to equity at a set interest rate, you need to borrow the money as a mortgage product or term loan (where the contract prevents the lender from arbitrarily calling the loan or changing the interest rate).

The downside of borrowing as a mortgage is that you have to pay interest on the money right away (even if you don’t need it immediately), but the benefit is that the lender can’t pull the rug out from underneath you at their whim. If you are counting on using the equity of your home over the next few years to fund your living costs or complete a necessary project, you may want to consider getting those funds borrowed as a mortgage now to make sure you’ll have them when the time comes.