Why you should care about the next interest rate hike
When the Bank of Canada make an interest rate announcement it can be hard for the average Canadian to understand how it affects them. This is in part due to a lack of understanding around what the Bank of Canada actually is and what it does. By way of a very simple explanation, the role of the Bank of Canada, also known as the central bank, is to take measures to protect the Canadian economy.
What is the role of the Bank of Canada?
The Bank of Canada helps keep the inflation rate low, which protects the economy and jobs, and this, in turn allows Canadians to go about their business and day-to-day lives. The Bank of Canada will raise interest rates in an effort to reduce consumer spending and personal debt levels, and stabilize housing costs; the more it costs us to borrow money, the less access to credit we have. This ultimately protects us from economic upheaval. When there is no recession it can be a hard pill to swallow that rates are increasing to protect us in the future, but we know the measures generally work because Canadians didn’t experience a housing crash like the United States did with the economic downturn of 2008/2009.
Two ways the Bank of Canada is different than my bank
The Bank of Canada is the banker’s bank. It is who our banks do business with and where our banks borrow their money. Our banks are businesses and need ways to borrow and invest just like we do. They must qualify, albeit using different criteria, to borrow money just like average Canadians must do when we want to take out a loan or mortgage.
A second very important difference is that the rate at which the Bank of Canada lends money to other banks and major financial institutions (called the overnight rate), this essentially determines the rates at which our banks lend money to us. Our bank sets it prime rate based on the Bank of Canada’s overnight rate. It is precisely this difference that makes headlines each time the central bank makes a rate announcement.
Do Bank of Canada announcements affect all interest rates?
When the central bank raises or lowers the interest rate it charges our banks to borrow money, our banks adjust the rates they charge us. The most obvious way we see and feel these changes is with variable rate loans, lines of credit and mortgages. If we are being charged prime plus 2.5 per cent on our line of credit, or prime less 0.25 per cent on our mortgage, this affects how much interest we pay our lender. It can also affect our payment amount if we lowered our payment to the interest rate we are being charged, rather than make a slightly higher payment to protect ourselves against interest rate fluctuations.
Fixed rate loans and mortgages can be affected as well, but the way that happens is not as straightforward as it is with variable rate products. Interest rates on credit cards are usually not affected by Bank of Canada interest rate changes, but it could happen once there are many increases over a period of time. Our financial institutions can also change their rates at any time, independent of a Bank of Canada rate announcement.
Is a quarter point change really that big a deal?
A quarter point is another way of saying 0.25 per cent, and a single quarter point rate hike on its own might not be all that significant. However, over time, the additional money you pay in interest can add up to tens of thousands of dollars. And if one small rate hike is followed by three or four more, all of a sudden, your line of credit interest rate has gone up by a full percentage point or more. And that is a big deal.
Example:
For example, with a $400,000 mortgage, amortized over 25 years with an interest rate of 3.45 per cent (the current prime rate at most financial institutions), the monthly payment would be $1,986. If the rate increases to 4.45 per cent, the monthly payment increases would be $2,202, a difference of $216 every month. However, to even qualify for this mortgage your budget must be able to afford a payment based on the current five-year conventional rate which is posted at 5.34 per cent right now.
Think about paying $200 to $400 dollars more each month on your loans and mortgage – would your lifestyle have to change to make that happen? Where would the extra money come from? These are tough questions for many people living pay cheque to pay cheque at their current interest rates.
How Client First Mortgage Solutions Can Help You
Whether you are buying a home or refinancing an existing home, it is important to make informed finance decisions that will help make home ownership viable and affordable over the long term. With interest rates on the rise, the best decision you could make would be to talk with one of our experienced Mortgage Brokers. They can help you to plan and review your mortgage options, terms and conditions and prepare you for Managing your Mortgage in the future. Contact us today.
Original Article – The Province – May 28, 2018
