The Effect of A Higher Interest Rate

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The Effect of A Higher Interest Rate

The much-anticipated announcement by the Bank of Canada (BoC) regarding raising interest rates was revealed today. The BoC will be raising the overnight rate by 0.25% to 0.75%. This is the first increase in interest rates since 2010.

Senior Deputy Governor Carolyn Wilkins indicated that the nation’s recovery is broadening across regions and sectors. The country saw strong first quarter momentum with economic growth of 2.8%.

The recovery included:

  1. 70% + of industries experienced growth;
  2. The labour market improved;
  3. Demand in energy-dependent provinces strengthened

The BoC’s decision to raise interest rates will have an effect on other interest rates, including mortgages. Homeowners and prospective buyers will all be affected in different ways.

Homeowners with fixed mortgage rates will have no immediate impact. Only when the mortgage comes up for renewal would the higher rates affect payments.

Homeowners with variable mortgage rates could see their payments remain the same or increase. For those individuals where the payments would remain the same, adjustments would be going on behind the scenes.  More money would be going to pay interest rather than the principal. This will have an overall effect as to how long it will take to pay off your mortgage. Variable mortgage rates are tied to a lender’s prime rate, minus the discount that was negotiated. The prime rate is guided by the Bank of Canada’s overnight rate.

Prospective buyers will notice that it could become tougher to qualify for a mortgage. Last fall, the federal government unveiled rules that require prospective home buyers to undergo a “stress test”. Currently, the stress test is calculated at 4.64% amortized over 25 years. Now that the Bank of Canada’s rate has started to climb, some home buyers will be “stress tested” at a higher rate. Making home ownership more difficult to obtain. Secondary lenders such as Home Capital Group will be more appealing as buyers will be looking to find the best possible option to obtain a mortgage.

The decision to increase the overnight interest rate to 0.75% by the Bank of Canada is not that overwhelming to the market. However, due to the earlier measures put in place by the Ontario government to cool the housing market and the overall media sensationalization, another slowdown in buyer activity could be expected. The pool of buyers would be lessened and thus less competition in the market. Consequently, with overall lower prices, this could open the door for further foreign buyers. Foreign buyers were responsible for 9.1% of the homes purchased in York Region during April 26 and May 26.

The next scheduled date for announcing the overnight rate target is September 6.


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