Consumer consternation has abounded amid the Bank of Canada’s most recent interest rate hike, which brought its overnight lending rate to 4.5%, forcing many to tighten their belts, but the fallout doesn’t have to be so dramatic.
The central bank indicated that we’re entering a period of relative calm. For starters, most observers agree that if there’s any movement this year, it could be a quarter-point decrease to the overnight lending rate, although we’re not so convinced.
StatCan’s most recent job report revealed a 5% unemployment rate, negligibly higher than its record-low figure of 4.9% this past summer, however, in our opinion, such a historically low number may impel the Bank of Canada to increase its overnight lending rate by 25 basis points this month.
It sounds worse than it is, and here’s why you shouldn’t panic.
As painful as payments have become for variable-rate mortgage holders of late, switching to a fixed-rate pact wouldn’t be as beneficial as most might think. Fixed-rate mortgages are determined by the bond yield, and while it decreased over the last few months, it more recently surged by 40 basis points.
Additionally, penalties for breaking such terms are exorbitant, further elucidating the importance of riding out Bank of Canada Governor Tiff Macklem’s aggressive rate hiking regime. To boot, Canada’s Schedule I financial institutions are also dissuading borrowers from switching into fixed-rate mortgages by deploying a host of disincentives.
The interest rate differential (IRD) penalty will skyrocket once interest rates begin falling. So, let’s say you switch to a 4.99% fixed rate mortgage even though there’s a strong chance the variable will drop to around 3.5% in 18-24 months, it’s bad enough that you will probably be kicking yourself. More importantly, however, the penalty for breaking that fixed term to return to a variable-rate mortgage pact would become at least 5% of the outstanding balance, which, using a $700,000 mortgage balance, would be $35,000.
That isn’t exactly easy to absorb in the current inflationary environment, either. Speaking of which…
Inflation continues proving a spanner in works for Canadian households, and because it is not falling as quickly as policymakers had hoped, and also because consumer spending has already curbed considerably, it stands to reason that if the Bank of Canada raises its overnight lending rate again, it would most likely be the final hike this year.
Higher interest rate payments have put the squeeze on borrowers, but despite the rising tide of headwinds, they still have ample strategies at their disposal to ensure their mortgages pay-downs include principal payments that protect will equity in their homes.
This is why securing the services of a veteran mortgage broker is crucial: a broker worth their weight in gold doubles as their clients’ lifelong financial planners—and at a fraction of the cost of hiring a financial planner. And no, going into your bank to meet a representative—who may mean well—isn’t the same thing, especially because you will be at their and the bank’s mercy.
At Mortgages.ca, depending on where our clients are in the life cycle of their mortgage, as well as the type of pact and terms of the deals, we generally recommend tightening spending so that the frequency with which they make payments increases, thus ensuring both principal and interest are paid down.
Although it might seem like a tall order amid consumer price index (CPI) volatility, it isn’t as complicated as it sounds. For example, if you’re in the habit of eating out on a weekly basis, the savings of eating out once a month instead would be immense. The same rule applies to other non-essential outlays, like going on vacation or enjoying entertainment.
It is also during times like these that debt consolidation makes the most sense because it can save up to $2,000—and, in some cases, more—in monthly cash flow.
Finally, another way variable-rate mortgage holders can weather the storm and make the most of their elevated payments until interest rates fall again is to extend their amortization periods. Doing so substantially reduces monthly mortgage fees—and if they curb spending elsewhere and maintain current payment amounts, they will be paying down principal and growing their equity.
Mortgages.ca brokers have a big bag of tricks to help their clients, and these are just some of the strategies we’ve been using during this most recent economic turbulence.
Stay tuned for plenty more.
