Canadian homebuyers are scrambling for cheap mortgage debt, often with variable rates. The latest Desjardins’ research note shows they should expect to pay a lot more in two years. As the Bank of Canada (BoC) hikes the overnight rate, those with variable mortgages will see costs rise. Desjardins’ calculations see those costs more than doubling within the next two years.
Canadian Interest Rates Are Expected To Soar
Variable rate mortgages see their costs fluctuate with the lender’s prime interest rate. The prime rate is based on the BoC overnight rate, which moves with policy. When the overnight rate falls, variable rate mortgages see interest costs drop too. The opposite is also true — a rising overnight rate means higher variable rate costs. Often payment stays the same, but the amount applied to the principal changes. In exchange for the volatility, it’s offered cheaper than fixed rates at sign up.
Canadian Variable Rate Mortgages Are Forecast To Double
Canada’s variable rate mortgages are dirt cheap right now, but that’s about to change fast. They should begin climbing in March, when the BoC is expected to make its first rate hike. Desjardins expects two more hikes next year (2023). The overnight rate is forecast to rise from the current 0.25% to 1.75% by the end of next year. This will significantly raise the cost of interest that variable rate mortgage borrowers pay.
Canadian Mortgage Rates Expected To Rise
The weighted average of mortgage interest costs and the Desjardins forecast.
Source: Bank of Canada; Desjardins.
By the end of next year, variable rate mortgages should see interest more than double. The Desjardins forecast shows variable mortgage interest hitting 3% by mid-2022. After doubling, costs will add another half point to 3.5% by the end of 2023. On the one hand, it’s a lot more interest this segment of borrowers should expect to pay. On the other, those mortgages are still dirt cheap. If you’re seeing higher rates as a burden here, you’re looking at it the wrong way. The period of cheap rates was more so a gift, especially when you see how little variable rates rose compared to fixed rates.
The Risks From Rising Variable Mortgage Rates Is Overstated
There is a lot of hubbub on higher interest costs crippling households, but that’s mostly just noise. “Still, the amount of an approved loan is not expected to be immediately affected, since it’s already set at a rate higher than the one offered by the financial institution in accordance with federal government regulations,” says Hélène Bégin, a senior economist with Desjardins.
The financial institution is referencing the B-20 Guidelines, a.k.a. the “stress test.” Stress test rates are much higher than even the most ambitious rate forecasts. Both the size of the loan and the borrower’s payment ability are ready for much higher rates. Many of the negative impacts from rising rates on variable borrowers are overstated.
Variable rate mortgages are now the loan of choice, dethroning the 5-year fixed. This is largely due to the BoC not raising rates while inflation drove other loans higher. As variable costs begin to finally rise, we might see a slowdown in purchasing.
Investors, the fastest growing segment of buyers, will see profitability reduced. After all, higher interest costs will squeeze margins.
Buyers that rushed into the market to capitalize on cheap debt but chose variable rates will also slow. Some saw this as their last chance for free money, doubting the interest rates will climb. If they do climb as forecast though, they won’t be saving a whole lot of money if they purchased it recently.