The Bank of Canada’s latest interest rate hike is a signal that more mortgage holders will be facing higher payments for a longer period of time than previously expected, as more long-term contracts continue to expire, says Rob McLister, editor of MortgageLogic.news.
“The psychology was that we were most likely in a pause and we didn’t have to worry about any hikes at all and now we’ve come to learn, based on the bank’s statement today, that the bank is a little more worried about inflation remaining sticky,” said McLister.
Whereas many economists predicted earlier this year interest rates may dip in the last quarter, the bank turned on that notion after seeing inflation figures higher than expected (4.4 per cent in April).
The bank said employment rates remain high, demand for services continues and spending on interest-sensitive goods has increased, as housing market activity picked up in the spring.
“Overall, excess demand in the economy looks to be more persistent than anticipated,” the bank stated Wednesday.
And so, with a quarter-point increase to its overnight rate, now at 4.75 per cent, Canada’s big five chartered banks were quick to respond with prime rate increases of their own — now at 6.95 per cent.
McLister sees the increase as a sign of elevated interest rates over a longer term now, meaning fewer mortgage holders will be able to escape the peak of the historic hiking cycle.
There are some already experiencing this “sucker punch,” said McLister — that is, anyone on a variable rate contract or anyone who is planning to buy a home.
In February 2023, 25.6 per cent of mortgage holders were on variable terms, according to the bank, and McLister says all of them, at this point, will either have their payments increased or have their payments go entirely to interest.
At the end of May, 35 per cent of mortgage holders have seen higher payments, relative to February 2022 when rates began to hike, from 0.25 per cent, according to the bank.
By the end of this year, 47.2 per cent of mortgages will experience higher payments and by the end of 2024 the proportion jumps to 65 per cent.
McLister said there may be another hike this year and he does not expect rates to decline until the end of 2024, based on the information available to him.
Right now, five-year fixed mortgage rates are about 5 per cent, with slight variations depending on personal situations, said McLister. Back in 2019, the rates were hovering around 2.5 per cent. McLister said the rates may rise to about 5.5 per cent, following today's announcement.
A person who borrowed $500,000 in summer 2019 on a new five-year term at 2.5 per cent, over a 25-year term, is currently paying $2,239 monthly. Fast forward to summer of 2024, if rates remain where they are today, that person will owe $423,190 and should they maintain their amortization period (now 20 years) at 5.5 per cent interest, their monthly payment will spike to $2,896 — a $657 jump.
In some cases, mortgage providers may extend amortization periods to lower the monthly increase, a trend the bank observed in its May 2023 financial system review: "The share of new mortgages with an amortization period longer than 25 years increased from 41% to 46% over 2022. In 2019, this share was 34%."
But the bank notes this is a financial vulnerability for borrowers, as equity is built more slowly.
This year (Q1), the average mortgage loan in B.C. is $429,370, according to the Canada Mortgage Housing Corporation. In Metro Vancouver, the average is $487,045 and the national average is $320,298.
McLister notes five-year rates vary depending on market expectations, so if there’s an economic slowdown, rates may drop with the expectation the bank will soon drop its rates. McLister said it is that expectation that is leading more people to choose two- or three-year terms, in order to eventually switch to a more favourable variable rate, with the overnight rate now lower.
But University of British Columbia economist Henry Siu says there is no telling what may happen in the year ahead. What is known is what the bank is signalling, said Siu — and that’s a “macro economy that’s still running pretty hot.”
While it may not come as comfort for variable rate mortgage holders or those facing renewal, the bank’s decision was “a good call,” said Siu.
The primary intent of the bank is to get inflation to one to three per cent, said Siu. To do this, demand on services and products needs to abate and higher borrowing costs can help to achieve this.
Siu said people will need to reconsider spending and businesses will likewise need to rethink loans to make further investments.
Siu said nobody can be sure of when interest rates will decline but at this point he suggests it is most likely to occur by the end of 2024.
“Certainly, this hike will put some brakes on the labour market but it’s unlikely we will get a sharp spike in unemployment anytime soon,” said Siu, who also notes consumer spending is still growing robustly.
“I would say concerns of a recession need not be too elevated. The Bank of Canada seems to be achieving its goal of bringing inflation down, albeit slower than desired,” said Siu.
Interest rates are also having an immediate impact on payments on short-term or floating rate loans, such as lines of credit.
Canada’s household debt is the highest in the Group of Seven nations, but Siu does not see this as a new phenomenon; rather, he’s confident the country has the ability to manage it.
“Household debt matters in so much future income is not able to pay it back,” said Siu.
But there appears to be ground-level pressure on indebted Canadian households, based on a recent poll by Angus Reid, reporting that the proportion of homeowners who find their mortgage difficult to manage has risen from 34 per cent to 45 per cent, since June 2022.
“Overall, half (46%) say they are in worse shape financially than they were last June. Two in five (39%) are holding steady, while a handful (14%) say they are trending positively,” the poll found.
Relatively higher interest rates also appear to be putting home buying on hold, according to a Bank of Montreal survey, finding “over two-thirds (68 per cent) of Canadians are planning on waiting until mortgage rates drop to purchase a home.”
