Briand Melanson has never shied away from risk.
Last summer, when it came time for the professional musician to find a mortgage for his first condo, in the Soho Condominiums building on Toronto’s waterfront, he went with a variable-rate mortgage, where the interest rate is tied to the banks’ prime rate, which was 2.45 per cent at the time.
Shortly after, with rates still low, he purchased a second condo to rent out, just a 10-minute walk away, also opting for a variable rate.
Then came the rate hikes that economists had been predicting for months.
On March 2, the Bank of Canada hiked its overnight rate by 0.25 per cent. That was followed last Wednesday by an even bigger rate hike — 0.5 per cent — that saw the overnight suddenly double to one per cent. It was the biggest jump in decades and Canada’s big banks quickly ratcheted up the prime rate to 3.2 per cent.
Now, like so many other Toronto homeowners with variable rates, Melanson is feeling the stress of watching his rate rise in real time — and he’s worried about just how big his monthly payments will get.
He should be concerned.
Economists say interest rates on mortgages will rise rapidly over the next two years to offset soaring inflation, which reached the highest level in 30 years at 5.7 per cent in February, well above the Bank of Canada’s two per cent target.
The prime rate will likely jump to 4.45 per cent — or even higher — by the end of the year.
“If rates rise that much I’d squeeze my dime to make that work,” said Melanson, who’s now considering locking in to a fixed rate to protect himself in the face of uncertainty.
Homeowners with fixed-rate mortgages and those looking to buy could be in trouble too.
Many homeowners with five-year fixed rate mortgages locked in at around two per cent. Given a typical house price ($1.3 million was the average price for home in Toronto in March, believe it or not), a 20 per cent down payment and a 25-year amortization, such homeowners are likely paying about $4,400 a month on their mortgages.
If their term came due now, the best rate they could find would be about 3.8 per cent, meaning their monthly payments would jump up to about $5,300.
But that might be a best-case scenario — some economists say we could see rates go a lot higher than that.
Rising interest rates make it more expensive to borrow money from lenders, cooling economic activity and price increases, to help control inflation, said Derek Holt, vice-president and head of capital markets economics at Scotiabank. Rate increases also impact the cost of loans and credit, so mortgage rate hikes aren’t the only concern among Canadians.
Interest rates in the bond market, which are used to price fixed-rate mortgages, have been increasing for almost a year, resulting in higher rates for fixed-rate mortgages, he added.
While interest rates may not hit the double-digit territory seen in the early 1980s — rates soared to more than 20 per cent in 1981 — they could reach levels not seen in Canada since before the recession, when rates were above six per cent.
“The Bank of Canada has fallen way behind on inflation,” said Philip Cross, senior fellow at the Macdonald-Laurier Institute and former chief economic analyst at Statistics Canada. Especially as economists predict inflation will reach 6.5 per cent by the summer.
“Raising the overnight rate 50 basis points makes sense because they have to catch up. We should be headed toward interest rates of five to six per cent and it will need to happen in the next couple of years. We need to slow inflation down.”
Douglas Porter, chief economist and managing director of BMO Financial Group, agreed that the Bank of Canada needs to make up for lost time after keeping interest rates at extreme lows for too many months. “There was no justification for it,” he said.
“There is an element of urgency for the bank to raise rates quickly to bend inflation. They stayed at the party too long.”
A five or six per cent prime rate can’t be ruled out, he said. In 2007, the prime rate hit 6.25 per cent and interest rates on five-year fixed mortgages hovered around the same mark.
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While the five to six per cent range isn’t “unbelievable” Porter said, it is in “aggressive territory.”
If it happens, Toronto homeowners could see their monthly payments shoot up by thousands, whether they’re in a variable-rate mortgage or a fixed.
For instance, if a homeowner with a five-year fixed rate at two per cent has to renew in two years at five per cent, they could see their monthly payments jump from about $4,400 to $6,000 a month. If they have to renew at six per cent, their monthly payment would shoot up to about $6,600 — an increase of more than $2,500 a month.
With inflation veering out of control and prices for food, gas and other essentials rising quickly, many could find themselves in over their heads, forced to renegotiate mortgages with longer amortization periods, cut back drastically on spending, or — in extreme cases — having to sell their homes.
Already, homebuyers looking to break into Toronto’s overheated market are getting discouraged.
Helly Parikh and Vrushant Shah are watching the July closing date for their Brampton house race toward them quickly and they’re getting increasingly concerned about the size of their mortgage payments. They said negotiating an affordable mortgage rate is top of mind, and they can only afford a maximum of 3.5 per cent.
“Right now the fixed rate is close to four per cent, so it makes more sense to stick with a variable rate,” Shah said. “But in a couple of years, it might be more expensive to do a variable rate than to lock in now. It’s a tough situation.”
Even at 3.5 per cent, mortgage payments on their $1.1-million detached home will make up a big chunk of their after-tax income. If the rate comes in higher, the couple will have to dip into savings and cut back on personal spending.
“It’s a huge challenge, we don’t know what will happen down the road,” Shah said.
Christopher Alexander, president of Re/Max Canada, said he’s only worried if the bank decides to “jack up rates quickly” versus a gradual approach.
“If they were to raise it (the key policy rate) by one point in April, another point in June and another in August, that could be problematic, as it would cut a lot of people out of buying power and have a big impact,” he said.
The current five-year fixed rate isn’t alarming for Alexander, as pre-pandemic interest rates were in the mid to high fours, and people were still buying property.
And then there’s the stress test, which ensures homeowners can afford an interest rate two per cent higher than their current rate. The stress test means homeowners can accommodate interest rates of four to five per cent, Alexander said. “Most have that affordability baked in.”
BMO’s Porter agrees that many homeowners will be able to handle the likely two per cent overnight rate increase. “But it will be painful for some individuals nevertheless,” he said. “A year ago we didn’t think we’d have almost six per cent inflation. We’ve clearly had a shock on a number of fronts.”
Eric Lombardi, housing advocate and founder of More Neighbours Toronto, said those who carry high mortgages will be more inclined to sell.
“Because we’ve seen such little supply over the last couple of years, it will have a temporary effect of bringing down home prices, but I’m not sure by how much,” he said. “Will this make housing more affordable? I don’t think so. There’s still the issue of too much demand and too little supply.”
Rising interest rates just add to the housing crisis as a whole, Lombardi said. “This is just another barrier for anyone who is locked out of the housing market and that’s devastating,” he added.
Meanwhile, those with variable rates are suddenly taking an intense interest in the latest outlooks from the Bank of Canada.
Ketan Kaushish and Neera Arya bought a home in East York during the pandemic with a variable mortgage rate of 1.2 per cent. The maximum amount the couple say they could afford to pay is three per cent. “Hopefully we will switch before it reaches that point,” Kaushish said.
If variable rates go higher he would be “absolutely concerned” and lifestyle changes would be needed to pay the mortgage. “Travel would be the first to cut back on. And we love to travel,” he said.
As for Melanson, he’s willing to see what happens with his variable-rate mortgages, but is keeping a watchful eye on rates.
“Right now I’m living comfortably at what I’m paying,” he said. “But I’ll be seeking out other options if rates become much higher.”
Clarrie Feinstein is a Toronto-based staff reporter for the Star. Reach Clarrie via email: firstname.lastname@example.org
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