The direction and size of the mortgage rate adjustments — and their impact on you —depends on many factors, including your type of mortgage (variable or fixed), your lender, the term of the loan, whether you are getting a new mortgage or refinancing an old one, and how the pandemic situation continues to unfold.
Here’s what you need to know about the recent changes in mortgage rates, and how they will affect your bottom line.
What’s Happening with Variable Rate Mortgages?
Financial institutions set their prime lending rates based on the Bank of Canada’s benchmark rate, known as the overnight rate. (It’s called this because it’s the rate of interest banks charge each other for a one-day, or overnight, loan.)
When the economy started to slow down earlier this year (in part, due to travel restrictions and a drop in oil prices in the face of coronavirus), the central bank did what it could to boost economic activity by cutting the overnight rate. The idea is to make borrowing cheaper for financial institutions and, in turn, businesses and consumers, so everyone still has cash available to spend and invest.
The “BoC” lowered the overnight rate three times in March, by 50 basis points each time, for a 1.5-percentage point reduction in total. As expected, Canada’s big banks correspondingly lowered their prime rates, first from 3.95% to 3.45%, then to 2.95%, and most recently to 2.45%. Other lenders set their own prime rates, and most dropped them as well.
This is good news for variable rate mortgage holders, whose interest charges are calculated using the prime rate, plus or minus a set percentage. So for example:
- If you have a variable rate mortgage with one of the big banks at prime minus 1.0%, your interest rate will now be 1.45% – down from 2.95% before the rate cuts.
- If you have a variable rate mortgage with one of the big banks at prime plus 1%, your rate will now be 3.45% – down from 4.95%.
As previously mentioned, many online mortgage lenders and other mortgagees have also lowered their prime rates, but those rates may be above or below the ones offered by the big banks.
How Much Interest Will I Save On My Variable Rate Mortgage?
The specific amount of money you will save in interest following a prime rate reduction by your lender depends on the size of your mortgage, the frequency of your payments, your amortization period, and the size of the rate cut itself.
Here are a few examples of how monthly payments would change on various mortgage balance amounts at different interest rates, assuming a 25-year amortization.
Monthly Payments, by mortgage balance and interest rate $300,000 balance $500,000 balance $700,000 balance 4.95% $1,736.29 $2,893.81 $4,051.33 4.45% $1,652.09 $2,753.48 $3,854.88 3.95% $1,569.94 $2,616.57 $3,663.19 3.45% $1,489.90 $2,483.17 $3,476.44 2.95% $1,412.05 $2,353.42 $3,294.79 2.45% $1,336.44 $2,227.40 $3,118.36 1.95% $1,263.13 $2,105.21 $2,947.30 1.45% $1,192.16 $1,986.94 $2,781.71
A 1.5% rate reduction would save you an average of about $235 per month on a $300,000 mortgage, an average of about $390 per month on a $500,000 mortgage, and an average of about $545 per month on a $700,000 mortgage. In other words, you’d save thousands of dollars in interest over the life of your mortgage.
Will the Payments on My Variable Rate Mortgage Automatically Go Down?
If you have a variable rate mortgage with adjustable payments, your payment amounts will automatically be reduced whenever interest rates drop. On the other hand, if you have a variable rate mortgage with fixed payments, your payment amounts won’t change, but more of each payment will apply to the mortgage principal and you’ll pay off your mortgage faster.
How does that work? Say you are in the first year of a 25-year amortization on a $500,000 mortgage, and your variable rate just went down to 2.45% from 3.95%. That means the interest portion of your monthly payment is reduced by $390. If your payments are adjustable, you’ll pocket that money each month, which is a savings of up to $117,000 over the life of your mortgage.
But if your payments are fixed, you’ll now be applying an extra $390 to the mortgage principal each month. That could shave up to 57 months — or 4.75 years —off your mortgage amortization, which could save you an additional $34,000 in interest (or up to a total of $151,000 in interest savings) over the life of your mortgage.
Fixed-Rate Mortgages — Are They on the Rise?
Fixed-rate mortgages are a bit of a mixed bag right now, with some lenders lowering their rates while others are raising them slightly as a hedge against future income uncertainty among borrowers. Of course, these changes won’t affect you if you already have a fixed-rate mortgage, unless you’re near the end of your term and looking to renew, or you’re thinking of refinancing (which we get into below).
In terms of new mortgages, it’s always best to shop around to see what your options are. Compare fixed and variable mortgages of various terms, not only in regards to the interest rates offered but also look carefully at portability (if you expect to move before you pay off the mortgage), allowable prepayment amounts, penalties for breaking your mortgage contract, convertibility (to extend term or lock-in to a fixed rate) and cashback features.
BMO, for example, currently has a one-month payment cashback offer on its 5-year fixed rate closed term mortgages, with a minimum amortization period of 25 years and a principal amount of at least $50,000. The offer is eligible for new mortgages as well as those that are switched from another financial institution.
Should I Refinance My Mortgage?
It depends. Prime rates haven’t been this low since 2010, so it’s worthwhile to find out what the penalties would be to refinance your mortgage or break your contract and switch to a new one. Compare the difference between the penalty charges and how much you’d save in interest costs at your new rate to see if it makes sense for you.
Keep in mind if you are switching to a new lender, it’s like reapplying for a mortgage —which means you’ll have to pass the mortgage stress test. If you got your existing mortgage before the stress test came into effect in 2017, you might not qualify for your full mortgage balance.
Also, some reports indicate that lenders are two to three times busier than usual, perhaps because borrowers are contacting them to see if they can temporarily defer their payments while experiencing financial difficulties due to COVID-19. That means your refinancing request could be relegated to the bottom of the pile, with new home mortgage business and renewals taking priority.
Is It a Good Time to Buy a Property?
With COVID-19, you’ve got some hurdles to overcome to buy a house right now. With the government asking Canadians to stay home and keep a distance of at least two metres (six feet) from others if they must go out, open houses are a definite no-no. It’s possible some realtors may take clients on private visits of homes, but online tours are probably going to become the norm for a while.
Choosing to buy a house without an in-person visit, however, is just one of the many obstacles buyers must overcome at the moment. If your income has been affected by COVID-19, you might not qualify for a mortgage. Even if you were pre-approved for a mortgage, a layoff could derail your plans when your lender circles back for the usual check on your employment status two weeks before a sale’s closing date.
In a case like that, your mortgage could be denied, and you could lose your deposit. Worse, the sellers could come after you for losses they incur if they end up selling to another buyer at a lower price.
Personally, I wouldn’t want to face the prospect of packing up and moving in the midst of a global pandemic. But, if none of these things deter you, the low-rate environment could help renters who want to get into the housing market. Just make sure to leave room in your budget for higher payments when/if rates go up, and for any potential interruption in your income due to job loss or illness.
If you’ve got some cash sitting in a bank account and your financial situation is stable, you may want to consider investing instead. With stocks falling sharply, now is a great time to buy and potentially profit from the market downturn. An easy way to invest is to build a portfolio of low-cost ETFs and index funds using one of the best robo advisors in Canada or an online brokerage like Questrade. But if your risk tolerance is lower and you want to avoid stocks, stash your cash in a GIC — one of the safest investments you can make. Presently, EQ Bank offers a 1-year GIC at 1.50%* — which is one of the best interest rates on the market.
*Interest is calculated daily on the total closing balance and paid monthly. Rates are per annum and subject to change without notice.
If you have a variable rate mortgage, you’ll be paying less for the time being. It’s unlikely that the Bank of Canada will raise rates before the economy starts improving; if anything, it could lower rates even further to spur growth should the situation deteriorate.
If you have a fixed-rate mortgage, look into the pros (lower rates) and cons (penalty fees) for refinancing and switching to a different lender.
Finally, if you are comfortable buying a property that you’ve only seen online, have confidence that your income is secure, and don’t mind taking on the stress of a move during what may already be a tension-filled period, you could find it easier to qualify for a mortgage now that rates have fallen. If you’ve got money just sitting in a bank account, you may want to start investing instead.