What does the Bank of Canada have to do with mortgage rates? A lot more than you’d probably realize. The bank, which independently acts as monetary authority to help guide economic growth, has a number of tools to help it do so. For example, when the economy is slowing down, it may decrease interest rates, and in turn, drive the cost of borrowing down to incentivize spending. Conversely, when the economy begins to overheat, it may raise rates to discourage spending and encourage saving.
A change in the Bank of Canada’s key interest rates flow through the borrowing costs you and I see in our daily lives – the interest on our credit cards, the rate at which interest is charged on our mortgages and the interest on our savings account. Since the beginning of 2017, the Bank of Canada has increased its key interest rate three times: from 0.75% to 1.0% to 1.25%.[1] Indeed, these are not the borrowing costs we see day to day. Consider this rate the starting point for which all borrowing costs are determined in the country. Each bank also adds on an additional charge to compensate them for the risk of lending, the amount of time lending, and the credit quality of the borrower. Furthermore, mortgage borrowers have the option to take on a variable rate mortgage or a fixed rate mortgage, and the key interest rate impacts these differently.
First, let’s distinguish the difference between the two types of loans – variable and fixed rate.
- Variable rate loans mean that for each monthly period, the interest charged is determined by the key interest rate (set by the Bank of Canada) and a spread earned by the bank to take on borrowing risk. When the key rate stays steady, the monthly interest payment is the same. When the key rate goes up, the monthly interest payment goes up, and vice versa.
- Fixed rate loans means just that – your interest rate is locked in at loan initiation – i.e., fixed. Regardless of whether the key rate increases, decreases, or stays the same during the entirety of your mortgage, your borrowing cost remains the same.
Let’s take a look at an example. In the example below, powered by yourmortgage.com, we evaluate the costs over a 2-year period. The variable rate begins at 3.5% and as the key rate increases, it rises 0.25% every three months until it reaches 4.5%, then decreases again. The fixed rate remains fixed at 4% and the mortgage amortizes over a period of 25 years. Take a look at the output; in the example, the variable rate payer ends up paying more in interest because of rising interest rates, and as a result, has a higher remaining mortgage balance at the end of two years. Comparatively, the fixed-rate payer locked in an interest rate of 4% for the entirety of the mortgage period. If interest rates had declined; however, the variable rate payer would come out ahead.
With the Bank of Canada anticipated further key interest rate increases, does this mean the time to refinance and switch to a fixed mortgage is now? Not so fast. There are many other factors that come into play before the decision is made.
- Comfort – If the threat of rising interest rates keep you up at night, for your own peace of mind it may make sense to lock in a fixed rate mortgage and not worry about the direction of interest rates.
- Outlook – If you believe the Bank of Canada will rapidly raise the key interest rate over the duration of your mortgage, it may be advantageous to switch over to a fixed rate loan. However, it is worth assessing differential between the fixed rate and variable rate. For example, if you believe that your variable rate mortgage will increase from 3.5% to 3.75% and remain steady, it may be advantageous to keep a variable rate mortgage versus switching to a fixed interest rate loan.
- Other costs – Are there other costs you need to consider? Does your variable rate mortgage come with a penalty for early termination and refinancing? Or does your mortgage allow you to convert to a fixed rate interest at a low cost?
- Time horizon – Remember, mortgages are typically long-dated, from 15-30 years on average. It’s unlikely that the key interest rate will rise forever into perpetuity. Recall that central banks adjust this rate through market cycles to keep the economy running smoothly. It’s likely that during the course of a 30-year mortgage, the economy will speed up and slow. This is normal; concurrently, the key interest rate – and therefore, variable rate mortgage rates – will increase and decrease over time. It’s difficult to anticipate what average rate you will end up paying across market cycles over the course of 30 years.
What about fixed rate payers? Well, in a rising interest rate environment, it’s unlikely that a borrower will run to the bank and unnecessarily refinance their loans to incur a higher interest cost. Though, if they do find themselves in a situation requiring a refinancing of their mortgage, they can anticipate higher rates as well. Those borrowers keeping with the original terms of their loans will enjoy a locked in rate for the life of the mortgage.
What is important, is that mortgage borrowers should not prematurely panic. Most economists reporting to Bloomberg do not anticipate the Bank of Canada to rapidly make steep increases to the key interest rate anytime soon, and believe that slow 0.25% increases may be more appropriate. This ties back to the bank’s role to help guide the economy—rapidly changing rates could be detrimental. In light of this fact, it makes sense for borrowers to potentially take a wait and see approach and consider their own unique circumstances. According to the CEO of LowestRate.ca, over a 30 year period, most variable rate payers end up ahead of their fixed rate counterparts. While this article provides information on variable and fixed rate mortgages; ultimately, it is an individual’s unique circumstance that will drive the decision to make a change.
[1] Bank of Canada Key Rate website.
What does the Bank of Canada have to do with mortgage rates? A lot more than you’d probably realize. The bank, which independently acts as monetary authority to help guide economic growth, has a number of tools to help it do so. For example, when the economy is slowing down, it may decrease interest rates, and in turn, drive the cost of borrowing down to incentivize spending. Conversely, when the economy begins to overheat, it may raise rates to discourage spending and encourage saving.
A change in the Bank of Canada’s key interest rates flow through the borrowing costs you and I see in our daily lives – the interest on our credit cards, the rate at which interest is charged on our mortgages and the interest on our savings account. Since the beginning of 2017, the Bank of Canada has increased its key interest rate three times: from 0.75% to 1.0% to 1.25%.[1] Indeed, these are not the borrowing costs we see day to day. Consider this rate the starting point for which all borrowing costs are determined in the country. Each bank also adds on an additional charge to compensate them for the risk of lending, the amount of time lending, and the credit quality of the borrower. Furthermore, mortgage borrowers have the option to take on a variable rate mortgage or a fixed rate mortgage, and the key interest rate impacts these differently.
First, let’s distinguish the difference between the two types of loans – variable and fixed rate.
- Variable rate loans mean that for each monthly period, the interest charged is determined by the key interest rate (set by the Bank of Canada) and a spread earned by the bank to take on borrowing risk. When the key rate stays steady, the monthly interest payment is the same. When the key rate goes up, the monthly interest payment goes up, and vice versa.
- Fixed rate loans means just that – your interest rate is locked in at loan initiation – i.e., fixed. Regardless of whether the key rate increases, decreases, or stays the same during the entirety of your mortgage, your borrowing cost remains the same.
Let’s take a look at an example. In the example below, powered by yourmortgage.com, we evaluate the costs over a 2-year period. The variable rate begins at 3.5% and as the key rate increases, it rises 0.25% every three months until it reaches 4.5%, then decreases again. The fixed rate remains fixed at 4% and the mortgage amortizes over a period of 25 years. Take a look at the output; in the example, the variable rate payer ends up paying more in interest because of rising interest rates, and as a result, has a higher remaining mortgage balance at the end of two years. Comparatively, the fixed-rate payer locked in an interest rate of 4% for the entirety of the mortgage period. If interest rates had declined; however, the variable rate payer would come out ahead.
With the Bank of Canada anticipated further key interest rate increases, does this mean the time to refinance and switch to a fixed mortgage is now? Not so fast. There are many other factors that come into play before the decision is made.
- Comfort – If the threat of rising interest rates keep you up at night, for your own peace of mind it may make sense to lock in a fixed rate mortgage and not worry about the direction of interest rates.
- Outlook – If you believe the Bank of Canada will rapidly raise the key interest rate over the duration of your mortgage, it may be advantageous to switch over to a fixed rate loan. However, it is worth assessing differential between the fixed rate and variable rate. For example, if you believe that your variable rate mortgage will increase from 3.5% to 3.75% and remain steady, it may be advantageous to keep a variable rate mortgage versus switching to a fixed interest rate loan.
- Other costs – Are there other costs you need to consider? Does your variable rate mortgage come with a penalty for early termination and refinancing? Or does your mortgage allow you to convert to a fixed rate interest at a low cost?
- Time horizon – Remember, mortgages are typically long-dated, from 15-30 years on average. It’s unlikely that the key interest rate will rise forever into perpetuity. Recall that central banks adjust this rate through market cycles to keep the economy running smoothly. It’s likely that during the course of a 30-year mortgage, the economy will speed up and slow. This is normal; concurrently, the key interest rate – and therefore, variable rate mortgage rates – will increase and decrease over time. It’s difficult to anticipate what average rate you will end up paying across market cycles over the course of 30 years.
What about fixed rate payers? Well, in a rising interest rate environment, it’s unlikely that a borrower will run to the bank and unnecessarily refinance their loans to incur a higher interest cost. Though, if they do find themselves in a situation requiring a refinancing of their mortgage, they can anticipate higher rates as well. Those borrowers keeping with the original terms of their loans will enjoy a locked in rate for the life of the mortgage.
What is important, is that mortgage borrowers should not prematurely panic. Most economists reporting to Bloomberg do not anticipate the Bank of Canada to rapidly make steep increases to the key interest rate anytime soon, and believe that slow 0.25% increases may be more appropriate. This ties back to the bank’s role to help guide the economy—rapidly changing rates could be detrimental. In light of this fact, it makes sense for borrowers to potentially take a wait and see approach and consider their own unique circumstances. According to the CEO of LowestRate.ca, over a 30 year period, most variable rate payers end up ahead of their fixed rate counterparts. While this article provides information on variable and fixed rate mortgages; ultimately, it is an individual’s unique circumstance that will drive the decision to make a change.
[1] Bank of Canada Key Rate website.
