Canadian banks raise fixed rates to 4.5%. How does it affect your finances and home prices?

After a hike in bond yields seen last week, Canadian banks keep raising their fixed mortgage rates.

RBC, TD and BMO raised their 5-year fixed rates by 0.20-0.25% to 4.39%.

Such a decision follows an almost 0.10% increase in the Government of Canada 5-year bond yield, which affects 5-year fixed rates. On Friday, the 5-year bond yield reached an 11-year high of 2.93%. Since the start of 2022, bond yields have gone up by more than 1.65%.

It means fixed rates rose by about 0.40% in just a month. To make it clear, a 0.50% rate hike increases a monthly payment by almost $24-25 per $100,000 of debt (in case of a 25-year amortization).

Although it will not affect most borrowers with fixed rates, new borrowers and those renewing a mortgage will face much higher rates than just a few months ago.

As fixed rates keep growing, variable rates will probably go up again following the central bank’s next rate meeting on June 1, when another half per cent hike is expected. This would lead prime rate (the rate upon which variable rate mortgages and lines of credit are calculated) to 3.70%.

How will growing interest rates affect mortgage borrowers?

“As the rates are rising and the forecasts of the overnight rate reaching 2% by October looking quite conservative already, borrowing costs will also go up, increasing the average Canadian household’s debt payments by almost $2,000 next year,” – noted economists from RBC Economics.

“This will weaken spending power, especially in case of the lowest earning category of households which spend 22% of their after-tax income on debt servicing,” – they add.

Meanwhile, according to RBC, the pandemic helped increase savings among Canadian households.

“The pandemic may have raised debts, but it also left Canadian households sitting on $300 billion in savings,” – the RBC economists believe. “That’s a strong backstop, which is enough to cover almost a year and a half of total Canadian household debt payments.”

How will higher interest rates affect real estate prices?

Although the recent data showed home sales were down in April, real estate prices have remained steady in most of the country outside of Ontario. In the GTA, average prices have been down by almost 6%, although benchmark prices often react to changes later, so more price drops are almost guaranteed over the next months.

“Tomorrow’s homebuyers will have more difficulties with paying today’s prices if they’re paying 5% on their mortgage and not 2% like just a few months ago, or 1% a year ago,” – says real estate analyst John Pasalis, president of Realosophy Realty.

He says some don’t consider it a problem, as many borrowers have been qualifying at a stress test rate of at least 5.25%. However, he says it’s an oversimplification.

Today, the mortgage stress test is used to qualify borrowers at the greater of the contract rate plus 2% or the benchmark rate, which is 5.25% now.

“These are dynamic measures so they will change when rates do. It means the stress test will also go up, reducing the amount of debt a buyer can take on,” – Pasalis says, noting that the contract rate affects how much debt the borrower is ready to take on.

“A buyer who qualifies for a $1M mortgage may be ready to take on that much debt in case of a 1.75% interest rate, but not when the rate goes up to 4%, because under the higher rate the mortgage payment would be about $1,100 per month higher,” – he explained.

So if the rates keep growing, Pasalis says he “would not be surprised if we see home prices decline during the next 9-18 months due to homebuyers being unwilling or unable to pay today’s prices at tomorrow’s higher rates.”

Nevertheless, he says any price drop would “probably be temporary due to long-term fundamental factors that have been pushing home prices in Toronto up.”