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Penelope Graham | Blog,News

Bank Of Canada Hikes Rate: How Does This Affect Borrowers?

October 24, 2018

This guest post is written by Penelope Graham of Zoocasa.

In what is great news for the economy – but not so much for borrowers – the Bank of Canada (BoC) has opted to hike its trend-setting Overnight Lending Rate, a move spurred by strong market performance and newfound stability in U.S.-Canada trade relations.

The central bank’s rate, which is used by Canada’s consumer lenders to set their Prime cost of borrowing, has been raised by a quarter of a percent, to 1.75%. The increase was widely anticipated by economists and pundits following the successful establishment of the US-Mexico-Canada agreement, which paved the way for the BoC to tighten monetary policy.

“The new [USMCA] will reduce trade policy uncertainty in North America, which has been an important curb on business confidence and investment,” stated the BoC’s release.

The BoC also pointed to robust inflation, which remains 0.2% above its 2% target, steady consumer spending, as well as the stabilization of household debt, which has long been a major vulnerability for the Canadian economy. Much of this reigned-in spending is the result of higher interest rates and tougher mortgage qualification policies, which were put into effect in January to improve the credit health of borrowers, the Bank says.

Bank Of Canada hikes rate – and more to come

With all of these positive indicators now at play, the BoC stated that, as long as the economy remains stable, more rate increases will be inevitable.

“Given all of these factors, Governing Council agrees that the policy interest rate will need to rise to a neutral state to achieve the inflation target,” the BoC states. “In determining the appropriate pace of rate increases, Governing Council will continue to take into account how the economy is adjusting to higher interest rates, given the elevated level of household debt. In addition, we will pay close attention to global trade policy developments and their implications for the inflation outlook.”

How will this affect lending rates on personal loans?

Interest rates on personal loans depend on the individual’s credit history and credit score. However, borrowing from the big banks may become more expensive as rates in general increase in Canada. With consumer debt still a major vulnerability of the Canadian economy, some may consider a low-interest personal loan to consolidate debt.

How will mortgage borrowers will be impacted? 

Today’s rate hike will have implications for all mortgage borrowers, regardless of their down payment size – even those coming up for renewal on their terms. First-time and millennial home buyers will have an especially tough adjustment period, though, as they’ve never experienced borrowing costs this high.

Those currently in a mortgage term with a variable rate can expect to see their monthly payments rise in the near future, as lenders add the BoC’s hike to their Prime rate pricing. Those entering a new variable mortgage contract with a higher Prime rate of 3.95% will also pay more monthly on their mortgage – an additional $65 per month for a home priced at $487,000 (the Canadian average according to the Canadian Real Estate Association) – which translates to nearly $8,000 more paid each year.

However, the hardest hit borrowers will be those who need to undergo stress testing in order to qualify for a mortgage. These criteria require borrowers to qualify at the Bank of Canada’s benchmark five-year rate, which is made up of the average of the posted rates offered by the nation’s main lenders, rather than the lower contract rate they’ll actually be paying at.

For example, previously, a buyer earning $100,000 per year, paying 20% on their home purchase, and had taken out a 30-year amortization, would have qualified to borrow a maximum of $523,772 under the existing 5.34% stress test.

Assuming rising Prime rates increase this benchmark to 5.54%, said buyer will now only qualify for a maximum of $515,022, effectively stripping $8,761 from their home buying budget.

What should home buyers do?

With interest rates poised to rise even further, it’ll be a wise move for undecided buyers – especially those in pricey markets, such as Toronto real estate – to get a pre-approval as soon as possible.

Connecting with a mortgage adviser or broker is also a must when navigating a rising rate environment – not only will they help establish your maximum budget, they can also provide guidance and peace of mind that you’re getting the best financing possible as borrowing gets more expensive.

Penelope Graham is the Managing Editor of Zoocasa.com, a real estate website that combines online search tools and a full-service brokerage to let Canadians purchase or sell their homes faster, easier and more successfully across the nation, including the Toronto, Calgary, and Vancouver MLS. Home buyers and sellers can browse listings on the site, or with Zoocasa’s free iOs app.

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