The Bank of Canada (BoC) will be meeting next on Wednesday April 13, 2022, and in the last couple of weeks its senior officials have been giving speeches indicating that we should brace for faster and larger Prime Rate increases than they predicted earlier this year. Inflation numbers are coming in stronger than expected and the BoC is going to act aggressively to fight rising prices.
What has Changed since February?
The main issues causing inflation are still the same – supply chain disruptions and the effect of excess money injected into the economy due to pandemic aid programs and relief packages. However, Russia invading Ukraine, along with the sanctions imposed on Russia by western countries, combined with new COVID outbreaks in China, are all contributing to further supply chain disruptions and are pushing up prices even further. Combined with the inflation reports that came out in March showing higher than expected inflation numbers in Canada, the BoC is now preparing for much more aggressive actions in 2022 to curb inflation faster.
What Should I Expect?
Many economists are now predicting the Bank of Canada will raise Prime by 0.5% at their next meeting on April 13, 2022, and will likely make another 0.5% increase a few months later. The BoC typically moves interest rates by 0.25% at a time, so these upcoming increases will be unusually large and fast by BoC standards. Increasing rates quickly like this will have a substantial cooling effect on our economy as a whole, and will hopefully blunt inflation and slow price growth into 2023.
However, raising Prime also has a direct impact on everyone with variable and adjustable rate mortgages as well as Lines of Credit:
Adjustable Rate Mortgage: your mortgage payment will increase when Prime increases, so you continue to pay the same amount to principal with each payment but you pay more in interest.
Common lenders: Scotiabank, Merix, RMG, First National
Variable Rate Mortgage: your mortgage payment does not increase when Prime increases, but with each payment more goes to interest and less goes to principal and your mortgage ultimately takes longer to pay off.
Common lenders: TD, RBC, CIBC, BMO, most credit unions
Line of Credit: typically the minimum payment required is just the interest accrued, and so your minimum payment will increase as Prime increases.
I Have an Adjustable Rate Mortgage. How much will my payment increase?
A 0.5% increase to Prime will increase your mortgage payment by roughly $24/month for every $100,000 of mortgage debt (assuming a 25 year amortization). So if your mortgage is $300,000, your monthly payment would go up by $72.
I Have an Adjustable/Variable Rate Mortgage. Should I Lock it into a Fixed Rate?
The choice of being in an Adjustable/Variable or Fixed Rate mortgage always should always come down to weighing the pros and cons of each option against your personal budget and future plans.
Right now, if you want to lock in you will receive roughly 3.89-4.19% for a 5 year fixed rate. If your current mortgage is a pretty competitive adjustable/variable rate in the realm of Prime – 1%, you are currently paying 1.7% for your effective rate. Therefore, locking into a fixed rate will increase your mortgage interest rate by over 2% immediately. This will cause your mortgage payment to go up substantially right away, rather than waiting for slow increases to happen as Prime goes up.
What you get for locking into a fixed rate is security – you know exactly what your payments will be for the next 5 years. If the Bank of Canada raises Prime by more than 2% over 2022-23 and keeps it that high or higher over 2024-27, you will end up better off for having locked in.
However, if the Bank of Canada raises Prime by less than 2% over the next 2 years, or ends up lowering Prime back down in 2024-26 once supply chains recover and they need to prevent a possible recession, then you could end up better of having stayed in your adjustable/variable rate mortgage.
Examples with Numbers
For a client that has a $300,000 adjustable rate mortgage at Prime – 1% (1.7% effective) and a 25 year amortization, the monthly payment today is about $1,228.
Locking into a Fixed Rate
If the client locks into a 5 year fixed rate at 3.89%, the payment jumps immediately to $1,565. That’s an increase of $337/month.
If the client stays in their adjustable rate mortgage, they will see their payments increase over time as Prime changes. Assuming we see the Bank of Canada raise Prime by 0.5% in April, again by the same amount in June, and then by 0.25% in October and by that amount each quarter in 2023, the client will not see his payments reach the same as the lock in payment until the beginning of 2024 (almost 2 years from now).
|Date||Payment Amount (1st monthly)||Rate Change announced||Effective Interest Rate For Next Pmt|
** The above table reflects a hypothetical scenario demonstrating the impacts of possible Prime rate increases.
Risks of Adjustable/Variable Mortgages
- Prime could possibly increase faster than expected through 2023 or continue increasing to a higher peak than expected in 2024/25.
Today, most economists expect that Prime will increase by about 2% over the next 2 years, but that could change if inflation continues to be stronger than anticipated.
Risk of Locking into a Fixed Mortgage
- If Prime increases over 2022-23, but then starts to decrease back down as supply chains recover and governments want to avoid a recession, you are stuck paying a higher interest rate or paying a big penalty to refinance.
- If you cancel your fixed rate mortgage mid-term, you can potentially be charged an Interest Rate Differential penalty which is much higher than 3 months interest (the penalty on an adjustable/variable rate mortgage).
Reasons to Lock In
Peace of Mind: if you are uncomfortable with the idea of not having control over if/when your mortgage payments increase, or any type of financial risk makes you worry and stress out, you should lock in your mortgage to a fixed rate.
Fixed Income or Financially Constrained: If you have a fixed income (pension, annuity, etc) or your family finances are tight, then you may not be able to adapt to mortgage payments higher than a specific threshold. In this case, the security of a fixed rate mortgage might be best even though it means paying more in interest and having higher payments over the next few years. It’s like buying insurance – you pay more money in interest today for the guarantee of knowing your payments will stay within your budget.
Reasons to Stay Adjustable/Variable
Short term savings: If you have a competitive discount on your mortgage rate, you will be guaranteed to continue saving interest costs for the next 12-24 months even as prime increases.
Long term possible savings: If you are believe that Prime won’t continue rising through 2025-27 because the national and global economies and supply chains will be recovered by then, you will stand to save further interest costs in those years if the Bank of Canada starts to reduce Prime to avoid recession.
Flexibility: If there is a significant chance you may sell the mortgaged property in the next few years (to upsize for more space, downsize as kids move out, to relocate for a new job, etc), the penalty to cancel an adjustable/variable rate mortgage is usually much lower than that of a fixed rate mortgage.
My mortgage amount is different than the example above.
You can roughly calculate your own hypothetical payments from the above illustration by multiplying them by your mortgage factor. To calculate your mortgage factory, just take your mortgage amount and divide by $300,000.
For example, if your mortgage is $600,000, your mortgage factor is 2 and the approximate monthly payment for your size of adjustable rate mortgage in Nov 2022 would be $1,412 x 2 = $2,824 (again, assuming a rate of Prime – 1% and 25 year amortization).
I Would Like More Help
If you would like to discuss your specific scenario with one of our team of brokers, please don’t hesitate to book a Lock-In Consultation appointment. These are short phone conversations where we can quickly help you decide, based on your specific mortgage details, whether it makes sense to consider locking into a fixed rate.