Rate hike to ramp up cost of borrowing

Mortgages, credit lines and student loans to be impacted

While central bankers seek to temper inflation levels not seen in decades, a set of sweeping monetary policy decisions announced Wednesday is poised to crank up the cost of borrowing for consumers and cool a red-hot housing market that has surged more than 50 per cent since the COVID-19 pandemic began.

Governor Tiff Macklem and his team of economists, who launched plans to double the bank’s overnight interest rate from 0.5 per cent to one per cent, are also cautioning Canadians that another “forceful” rate hike could arrive as soon as June, when the Bank of Canada is scheduled to announce its next rate decision.

For many consumers, these increases mean interest payments on outstanding debt are likely to rise as mortgages, student loans, credit lines on car purchases and more grow increasingly expensive.

“Higher and faster rate hikes will affect mortgage affordability for a significant population of homebuyers,” said Sung Lee, a mortgage broker and analyst with Rates.ca, following the announcement.

The central bank said housing market activity “which has been exceptionally high, is expected to moderate.”

The hike may not sound like much — given historical rates that, until the 2008 financial crisis, typically sat above two per cent — but the bank’s decision marks its most aggressive hike since May 2000, when central bankers sought to tame the torrid pace of economic growth at the turn of the millennium.

The policy is designed to curtail demand by making it increasingly expensive (and, for some consumers, prohibitively expensive) to borrow money from banks and other financial institutions.

1%

Key interest rate rises 0.5%, the largest increase in two decades 40%

Canadian mortgage holders who have to renew in next two years

The same thinking applies to companies, which will now pay more on loans used to finance capital ventures.

Already, rising mortgage costs appear to have started to cool home prices, which rose more than 50 per cent during the pandemic.

“Major banks have already pushed fixed rates higher several times over the past few weeks, with some approaching the four per cent mark for uninsured products,” said Lee. Canadians embarked on an epic mortgage binge during the pandemic, growing national household debt to a record $2.5 trillion by the end of 2021.

Nearly 40 per cent of Canadian mortgage holders will have to renew their mortgages in the next two years, according to a recent survey from Mortgage Professionals Canada, meaning those holders’ payments are likely to rise due to the recent rate hikes.

Based on Ratehub.ca’s mortgage payment calculator, a homeowner who put a 10 per cent down payment on an $800,000 home with a five-year variable rate of 1.15 per cent (amortized over 25 years) currently makes a monthly mortgage payment of $2,847.

Under the Bank of Canada’s 0.5 per cent increase, the homeowner’s monthly mortgage payment will rise to $3,019, meaning the homeowner will pay $2,064 more per year on their mortgage.

Among those who will bear the brunt of rate hikes are prospective first-time homebuyers who must pass the federal government’s socalled “stress test” to qualify for a government-backed mortgage. The test requires mortgage applicants to prove they can handle higher interest rates so as not to default on payments.

Mortgage rates are now high enough that many potential buyers will have to qualify at percentages above the stress test, which is presently 5.25 per cent or two per cent above the offered rate, whichever is higher, Lee noted.

“As mortgage rates rise, not only do borrowing costs become more expensive, it can also mean that potential homebuyers are qualifying at a rate higher than the current stress test of 5.25 per cent,” she said.

The most vulnerable consumers grappling with higher rates include those who took out hefty loans on home equity lines of credit, also known as HELOCs.

The popular and easy-to-access loan, which combines a mortgage with a secured line of credit, can cover up to 80 per cent of the borrower’s home value, and it now represents a substantial portion of Canada’s overall household mortgage debt.

While lowering demand for housing, experts have noted that rate hikes will not solve a sweeping affordability crisis in the market; counterintuitively, it will more likely exacerbate it as the cost of borrowing increases beyond the reach of many potential first-time buyers.

“If you had any intention of buying into this market, it would have been better if you did it yesterday,” said Philip Cross, a senior economist and fellow at the MacdonaldLaurier Institute.

“It’s going to be a lot more expensive 30 days or 60 days from now. At some point, these kinds of hikes shut down demand.”

Students with outstanding postsecondary debt — particularly those with floating-rate loans — along with average Canadians paying off a loan for a new car or SUV, may be on the hook for higher payments in the future, as well.

The best thing for indebted Canadians to do, for those who can, is to pay down outstanding debt before rates get higher, said Cross.

“For a small but significant part of the population, this is going to be difficult to deal with,” he said.

Consumer prices hit a three-decade high of 5.7 per cent in February, well above the central bank’s target range of one to three per cent.

A wide range of factors have helped drive up inflation — from intense consumer demand following the lifting of public health restrictions, to companies that have seized the moment to boost profit margins — but the bank has until recently been reluctant to hike interest rates in response.

The bank’s latest monetary policy moves suggest it has “lost the patience it demonstrated back in January,” when it took a pass on raising rates despite mounting pressure to do so, wrote RBC economist Josh Nye in a Wednesday report.

Despite the hikes, Bay Street economists anticipate the Canadian economy still has room to grow in the coming year while some consumers and businesses grapple with higher borrowing costs. Strong employment levels and household savings data appear to have boosted confidence within the central bank that the economy can withstand rate hikes.

“Both growth and inflation data have surprised on the upside and the bank sees the economic momentum extending,” wrote CIBC economist Avery Shenfeld on Wednesday.

“Simply put, the recent data leave little doubt that the economy can live with a jump to a one per cent overnight rate and, indeed, higher rates beyond that.”

Nonetheless, Shenfeld said, Wednesday’s decision leaves little doubt that the bank is getting tough on inflation.

“They brought out the big guns,” he wrote.

If you had any intention of buying into this market, it would have been better if you did it yesterday.

PHILIP CROSS SENIOR ECONOMIST AND FELLOW AT THE MACDONALDLAURIER INSTITUTE