It's Your Money  

Small rise in interests rates can result in a big cost to you

Cost of rising interest rates

On June 1, the Bank of Canada raised its prime rate by another 50 bps and also signaled additional hikes were coming soon.

Canadians with variable rate mortgages would be wise to keep an eye on announcements from the bank regarding these hikes and understand how they will be impacted.

Large jumps in Canada’s prime rate can have a serious impact on mortgage payments for anyone who holds a variable mortgage since these mortgage rates tend to rise and fall along with the bank’s prime rate.

Let’s say your variable mortgage rate was at two per cent, then by the end of the year it rose to three per cent after the prime rate increases. Here is an example of how that could impact various mortgage payments (assuming a 20-year amortization):

• A $600,000 loan at 2% has a monthly mortgage payment of $3,032.94

• A $600,000 loan at 3% has a monthly mortgage payment of $3,322

As you can see, a variable rate increase of one percentage point can mean thousands more dollars in mortgage payments over the course of a year. This could put considerable pressure on your cash flow, regardless of the level of your household income.

Whenever interest rates look likely to start climbing, some homeowners are likely to begin wondering whether they should lock into a fixed rate mortgage or continue to stay on the variable rate ride.

This decision often boils down to an individual’s appetite for risk. Some people feel more comfortable knowing that their interest rate (and therefore their mortgage payments) will remain the same. It certainly makes budgeting a lot easier.

Switching, though, isn’t quite that clear-cut. In some cases, going from a variable rate to a fixed rate mortgage could require you to break your current mortgage, which can come with a prepayment penalty which may or may not be significant. Some companies, however, will waive this charge for clients who want to convert their variable mortgage to a fixed rate of equal or longer term.

For lenders that charge a penalty to convert from a variable to a fixed rate mortgage, the amount of time you have left on your mortgage term may determine whether converting it is worth the cost. The closer you get to your term’s maturity date, the lower your costs are likely to be. However, should rates continue to rise, locking into a fixed rate sooner may save you more on interest costs in the long run.

There is something else to consider: how much and how frequently rates are expected to rise. While variable rates could move higher than current fixed rates over time, in the short term the fixed rate is likely to be pricier than your variable rate, so you’d need to plan for the additional costs.

There are also options available other than just straightforward variable and fixed rate mortgages. It’s possible to set up a variable rate mortgage with a fixed payment. When rates rise, you pay more in interest than principal and vice-versa if rates fall. The benefit is that, from a budgeting perspective, the amount you have to pay remains the same.

When it comes to mortgages, it is often best to start with a financial planner first to build out a full financial plan and determine what value of a home you can actually afford. They can help you map out the implications of each option in the context of your long-term goals.

Then, you can go see a mortgage specialists confidently knowing what type of mortgage you need (and how much you can actually afford and not what amount you happen to get approved for) so that they can then find the right provider for you.

This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.

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About the Author

Brett, designated as a chartered investment manager and certified financial planner, is the regional director (Okanagan) for IG Wealth Management.

In addition to his “day job," Brett was appointed to the board of directors of FP Canada (formerly FPSC) in 2014, named as the board’s vice-chair in 2017 and took over as board chairman in 2019. 

Brett has been writing a weekly financial planning column since 2012 and provides his readers with easy to understand explanations of the complex financial challenges that they face in every stage of life.

Enhancing the financial literacy of Canadian consumers is a top priority of Brett’s and his ongoing efforts as a finance writer and on the regulatory side through the FP Canada board focus on this initiative.   

Please let Brett know if you have any topics that you’d like him to cover in future columns by emailing him at [email protected]

The views expressed are strictly those of the author and not necessarily those of Castanet. Castanet does not warrant the contents.

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