Variable-rate mortgage holders will see their interest costs rise once again starting this week as prime rate rises to 5.45%.
The country’s Big 6 banks announced the increase following the Bank of Canada’s 75-bps rate hike on Wednesday. This latest move takes the Bank’s overnight target rate to 3.25%—300 basis points higher than it was in March and officially above the Bank’s “neutral” target range and into restrictive territory. It’s also the fastest pace of rate tightening since the mid-1990s.
But the Bank signalled that it’s not done with its rate hikes just yet.
In its statement, the Bank said the policy rate “will need to rise further” and that officials “will be assessing how much higher interest rates need to go” in order to bring inflation back down to 2%.
As of July, CPI inflation eased slightly from 8.1% to 7.6%, though core inflation continued to trend higher.
More variable-rate mortgages will hit their trigger rate
The rise in prime rate, upon which variable rate mortgages and lines of credit are priced, will translate into a little over $40 in additional monthly payments per $100,000 of mortgage for new variable or adjustable-rate mortgages, based on a 25-year amortization.
It also brings more variable-rate mortgages (those with fixed monthly payments) to their trigger point, where borrowers’ monthly payments are only covering the interest and are no longer paying down any principal.
RBC, Canada’s largest bank, recently disclosed that it expects roughly 80,000 of its variable-rate mortgage holders to hit their trigger rate within the “next couple of rate hikes.”
A stress test in excess of 7%
This latest rate hike also raises the hurdle for new variable-rate mortgage borrowers, some of whom will now be required to qualify at mortgage rates in excess of 7%.
This is particularly true for uninsured variable rates, those with a down payment of at least 20%, which will now average about 5.20%.
With rates now approaching a peak for this rate cycle, a growing chorus of voices are now questioning if the mortgage stress test—as it is currently structured—is still relevant.
The Toronto Regional Real Estate Board recently asked, “Is it reasonable to test homebuyers at two percentage points above the current elevated rates, or should a more flexible test be applied that follows the interest rate cycle?”
At a minimum, the board called on the Office of the Superintendent of Financial Institutions to consider removing the stress test for existing mortgage holders who simply want to switch to a different lender.
Where the Bank of Canada goes from here?
The Bank made it clear more rate hikes are forthcoming, and markets currently expect another 50-bps hike at the Bank’s October 26 meeting.
“We’re pencilling in a 50-bps rate hike for the October policy meeting, and will let the data flow over the next seven weeks sway that call either higher or lower depending on the strength/weakness in inflation and growth,” wrote BMO economist Benjamin Reitzes.
And while CIBC’s Avery Shenfeld agrees that the additional hikes beyond October will be a possibility, he said there must also be some consideration for the time it takes for rate hikes to start impacting inflation and the economy.
“A front-end loaded strategy for rate hikes is designed to take rates up quickly, but also behooves the central bank to pause at some point to see how the economy is coping, given that there is a lag in seeing that response in growth, and an even longer lag for its impacts on inflation,” he wrote.