Canadians have enjoyed low interest rates for the last decade but even more since the onset of the global pandemic. during that time, the Bank of Canada responded with a trio of rate cuts, bringing us to 0.25%. However, fast forward to 2022, we have already seen three interest rate hikes in response to soraring inflation rates which reached a 39-year high in May, at 7.7%
What does an interest rate hike mean if you're planning to buy a home, if you already have a mortgage, or are carrying any othe debt? Let's take a step back to better understand what causes these changes in interest rates and how a higher rate might impact you.
What causes Interest Rates to Rise or Fall?
The bank of Canada is our central bank, and alon with its Governor, is responsible for setting monetary policies, printing money, and the Bank's interest rate. Per the Bank, it principal role is "to promote the economic and finacial welfare of Canada" as defined in the Bank of Canada Act.
A good example of this is March 2020, when the Bank implemented a trio of interest rate cuts in an effort toprotect the Canadian economy from the fallout of COVID-19. The Bank's key interest rate remained unchanged for about 2 years, sittiing at 0.25%. A low rate aims to boost the economy when a slow-down is anticipated. It serves as a guideline for othe banks and lenders when they set their own interest rates- including mortgage rates. The hope is that reducting the cost of borrowing will encourage consumers to keep spending and thur. the economy keeps humming along.
Fast forward to post-pandemic July 2022. Bank of Canada has implemented multiple interest rate hies to slow down soaring inflation.
How will Higher Interest Rates Affect Me?
What happens when interest rates rise? As the econom recovers, interest rates will typically rise. However, as we saw in the wake of COVID-19 in a down economy, they will fall. When the Bank makes changes to the policy interest rate, similar chages can occur in short-term interest rates. This includes the Bank's prime rate which is often a reference point for big banks andothe lenders when they determine their own interest rates.
A higher interest rate means borrowing money is More Expensive. This applis to all debt. From car loans and student loans, to lines of credit, outstanding credit card balances and yes... mortgages. On the flip-side, if you have investments or money parked in a high-interest savings account, you may see higher returns.
If you already own a home and are locked into a fized mortgage rate, a higher interest rate won't affect your mortgage payments for the term of your mortgage. When it's time to renew, you may be doing so at a higher rate, which means less of your hard-earned mone is going towards paying down you principal loan.
If you have a variable-rate mortgage, an interest-rate hike would mean a larger portion of you regular mortgage payment will be allocated to interes, versus principal.
Meanwhile, those who are in the market to buy a home will feel a more-immediate pinch, in the form of a higher mortgage interest rate. And if you'rehoping to buy a home in a pricey market, such as Toronto or Vancouver, that pinch would feel more like a punch. Depending on the amount borrowed, even an increase of one percent can mean thousands more paid in interest over the life of a mortgage.
Those who are also carrying other forms of debt, such as credit card balances, will also get it with a higher cost of borrowing.
How Could This Change Impact Canadian Real Estate?
Might a higher lending rate cool the Canadian housing market? Potentially, One reason for the high demand and flurry of market activity that took place in 2020 and 2021 was the rock-bottom interest rate. This prompted many prospective homebuyers to get off the fence, so to speake, and expedite their purchase to take advantage of the attractive rate. (That is, if they could find a home to buy in this tight market.)
On the other hand, oculd a higher interest rate heat up the market? This scenario is unlikely once the higher rate is in effect. However, it's not unheard of for home-buying activity to pick up before an expected increase.
How To Prepare for Higher Rates Ahead
It's sale to say interest rates will rise, eventurally. Now that you have a better idea of how higher interest rates may affect you, what can you do to prepare for the inevitable pinch to your pocketbook?
- Pay down your loans as much as possible, while interest rates are still low. Wheather it's a mortgage or another type of loan, a lower interest rate means more of your payment goes toward paying down principal
- If you're carrying multiple debts, consider a debt payment strategy, There's many types of programs and guides such as debt avalance or debt snowball to help pay down those debts.
- If you'll be shopping for a home, get pre-approved for a mortgage. Not only does this give you a good idea of your home budget, but doing so also locks in the current (lower) rate for a period, often 90 or 120 days. And getting pre-approved cost you nothing.
- If you have a variable-rate mortgage, discuss your options with your lender or financial adviser, Consider locking it in for a fixed term at the current lower rate.
Of course, it's always wise to discuss the details of your financial situation and goals with an accredited financial adviser. And speaking of a professional help, We have over 35 years of real estate experience that can help you navigate the Alberta Real Estate Market. Let's find your next home, investment property and more.
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