As interest rates keep rising, buyers, sellers and homeowners are taking a hit. People are concerned, and rightfully so – monthly carrying costs for properties are skyrocketing, buyers are stepping back, sellers are waiting to list, and homeowners with variable rate mortgages and fixed rate renewals are really feeling the heat.
There’s a lot of information flying around these days – if you’re not 100% clear on what it all means, you’re not alone. Here’s a quick “what and why” rundown of inflation, the Bank of Canada’s rate increases, and how it’s affecting the GTA market.
Inflation 101
The inflation rate is a measure of how much prices for things like food, shelter and transportation go up over time. Over the last 20 years, it went up by about 1-3% a year. But recently, that slow and steady rise has taken a big jump, with prices going up 7% or more in the last couple of months alone. (Sticker shock at the grocery store is real.)
So that’s the “what.” But how about the “why?”
WHY are prices suddenly so inflated? All you have to do is look at the news. The pandemic has had a huge impact on the global economy. We’re facing huge supply chain issues, large-scale interruptions in global markets – and big shifts in the ways money moves and the way people spend.
Our demand for goods and services has grown, and business closures and supply issues mean companies can’t produce enough to meet the demand. If there’s a shortage of something, prices will go up – it’s basic economics. And then there’s the war in Ukraine, which is causing massive uncertainty and wreaking even more havoc on the global economy.
There are a lot of forces at work, and they’re all making prices go up so fast our incomes can’t keep up. The only way to slow inflation is to cut consumer spending – and that’s where the Bank of Canada interest rate hikes come in. Higher interest slows spending in two ways:
1. By making it more expensive to borrow. People spend less when interest rates are high.
2. By making saving money more attractive. When you can earn more on your investments, that’s an incentive to put cash into an RRSP or a mutual fund instead of spending it.
And that, in a nutshell, is why interest rates keep going up. But it’s also why they are unlikely to stay high in the long term.
The Bank of Canada’s goal is to stabilize inflation, not to cause a recession
If rates stay too high for too long and the government cuts spending too much, it can lead to a recession. Which nobody wants. In fact, that’s why rates were so rock-bottom at the beginning of the pandemic: when people stopped spending due to job loss, closures and general uncertainty, the Bank of Canada dropped the overnight rate to a historically low 0.25%. As intended, those ultra-low borrowing rates kickstarted spending – and overheated demand that drove up prices.
This whole interest rate thing is a balancing act. When things go too far in one direction or the other, the BoC’s job is to bring it back to the middle. As soon as inflation has gotten back to a healthy level, interest rates will start to come back down. Exactly WHEN will that happen? Nobody has a crystal ball – there are likely to be more increases on the horizon, but experts are predicting that rates may start to drop in late 2023.
Interest rates 101
Overnight rate. Prime rate. Bank rate. Variable rate. Fixed rate. They all mean something a little different, and it’s easy to get confused. Here’s a quick description of each one:
Overnight rate. This is the rate that’s set by the Bank of Canada. The current overnight rate (as of the last rate hike at the end of October) is 3.75%. This is NOT the rate you’ll pay to borrow – it’s the rate banks use when lending money to each other, not to the average Joe.
Prime rate. This is based on the overnight rate, but is generally higher. It’s the foundation for the interest rate banks charge consumers. Right now, the prime rate is 5.95%.
The actual interest rate you pay. The bank rate is based on the prime rate, but the rate you pay depends on the type of mortgage you get, your credit rating and other factors. It varies from lender to lender, so it pays to shop around (or get a mortgage broker to do it for you).
Variable rate mortgage. This is a mortgage where you pay the going interest rate. You aren’t protected if interest rates go up…but you’re in great shape if they come down. There are a couple of variations on this:
Your payments change based on the current rate.
Your payments stay the same, but the amount that goes to interest and principal changes.
Fixed rate mortgage. This is the most common type of mortgage: you lock in at a certain rate for a specified amount of time, like 5 years. The upside is that your payments are predictable and you’re protected from rate hikes for the loan term. The downside is that your interest rate is significantly higher than it would be with a variable rate. And if interest rates drop, you’re stuck paying the higher rate. And when it comes time to renew, you’ll be subject to whatever the current rate may be.
What do all the increases mean for your monthly budget?
Since the first increase in April, multiple hikes have brought the overnight rate to its current 3.75%. Every 1% increase means you’ll pay about $54 more a month per $100K owed – and the overall 3.5% increase from the low of .25% means $189 more per $100K. On a $700K mortgage, you’re looking at $1,323 more each month. That’s a big difference.
Read more: the cost of buying – February vs. today
How is it all affecting buyers, sellers and homeowners?
As interest rates rise, property prices in many parts of the GTA have dropped. But that doesn’t mean you’ll be paying less every month – even if a home is 20% cheaper now than at the height of the market, the higher interest will mean your carrying costs will be similar. You’ll just be paying way more in interest every month – and you’ll qualify for less.
There is one plus here: a lower initial price tag means you can get away with a smaller down payment, you’ll pay lower land transfer taxes (based on a percentage of the sale price) – and once interest rates come down again, your monthly costs will come down.
Of course, if you’re paying for a property outright, you’re in great shape to capitalize on lower property prices. But if you’re like most people, you have to borrow to buy.
Homeowners are being impacted, too.
Those with variable rates are seeing big increases to their monthly payments. The rates have gone up enough that many homeowners doing a fixed payment variable rate have had to increase their payment. The drop in property prices – and demand – is making life difficult for sellers as well. It’s not a sellers’ market anymore: homes are taking longer to sell, and most are selling for less than they would have earlier this year.
Are you thinking about buying or selling in this market?
Buyers – there are definitely opportunities to be had. And sellers, a good marketing and pricing strategy can still net you a fair price. Sign up on condos.ca or property.ca to do some research, search available listings – and connect with a Property.ca agent who can help you make the right move.