Lets examine some of the scenarios that would come with rising interest rates. If interest rates do rise:

- Mortgages will cost existing home owners more (especially variable rates because their not locked in). The monthly payments will increase.

- Home’s will become less affordable. This means that if a potential buyer could afford a $400,000 home at a 3% interest rate, they would not be able to afford that same home at a 4% interest rate.

If rates rise enough, homes prices may drop because buyers will simply not be able to afford current day prices. This could means that sellers might become “trapped” in their home. Here’s why:

If a home owner bought with 5% down and home prices drop by 5%, then this person can not really move. If they sell, they will have lost their equity. This means that they will not have any money for a down payment and will not be able to buy another home. If they need more space because their family is growing, or if they find a job on the other side of the city, too bad. They are stuck. Their only option is to sell and rent or to stay put.

Interest rates have generally declined for more than 10 years. In 2005, the overnight rate was near 5%. If you consider what it would take to get back to, the already low, 2005 rates, you could say that we have very little to fear for rapid rate increases. Even if the Bank of Canada raised rates by .25 basis points at each decisions (8 per year), it would take 2 years of consistent increases to get back to 2005 levels.

Many economist point out that each increase in the over night rate will make the value of the Canadian dollar increase (it’s already at 1.05/US$) and this hurt Canadian exports. Also each increase in the overnight rate will increase variable mortgage costs making monthly payments even more expensive. If homeowners need to pay more, it will make the Canadian consumer think twice about spending money , thus hurting the economy.

It looks like that a rapid rise in interest rates could be unlikely, but only time will tell. It’s alway good to examine the “what if” scenarios and make sure that, as Canadian homeowners, we are prepared for different possibilities. I imagine that employees at the Bank of Canada were one time Boy Scouts because they like to remind us to “Always Be Prepared.

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The Bank of Canada lending rate is reviewed 8 times a year. The specific dates can be viewed at www.bankofcanada.ca. These rate reviews are be becoming more and more important to Canadian homeowners who purchased homes with large variable rate mortgages.

According to a Toronto Star article, 60% of all mortgages in Canada are fixed rate mortgages and 35% are variable rate (5% have an adjustable rate mortgage). There are 5.7 million mortgages in Canada. This means that approximately 3.7 million Canadian homeowners have a fixed rate mortgage and another 2 million have with a variable rate mortgage. Because variable rate mortgages will raise and fall based on the Bank of Canada lending rate, 2 million people can be affected, up to eight times a year.

In a recent article, The Toronto Star writer, Tony Wong, points to a CAAMP report that says 3-4% (200,000 owners) of Canadian mortgage holders say that they “have absolutely no room for additional monthly increases in their payments.” He also points out that report shows another 13% (700,000 owners) of homeowners could not afford another $200 per month on their mortgage payment. In total, this is 900,000 Canadians that could be in financial difficulty if interest rates rise. (In the case of $200 a month increase: for anyone with a $250,000 mortgage, this is only a 1% increase in their mortgage rate.)

When PropertySold.ca talks to our friends, family, and customers, most people have the opinion that “there is no way that the Government will increase rates and put so many people in financial trouble.” We agree that the Canadian Government would not purposely raise interest rates “just because”, but there are so many different factors that effect the Bank of Canada rate. The Government might have no choice to raise the rate and the homeowners with unaffordable mortgages might just become a casualty of rate increases.

Recently the new rules have been created to try and slow Canadian’s appetite for housing and large mortgages. The maximum amortization has been reduced to 30 years, and CMHC insured home equity rules have been adjusted. The Toronto Real Estate Board reported that April’s sales were down by 17% and new listings had decreased by 30%. However, the average price increased approximately $40,000 from the previous April. The 9,041 Torontonians who purchased a home in April paid, on average more than anyone else…ever.

The Real Estate Market is very important to Canadians. More than 9 million Canadians own a home. Housing prices and mortgage rates affect so many people. It will be very interesting to see how rates move and whether the Government will be implementing more rules to slow down the number, and size, of mortgages taken out by Canadians. Some people suggest that instead of raising the interest rate and harming close to one million mortgages, that the Government might increase the minimum downpayment to 10%. This would result in slowing real estate sales and most likely reduce prices, but it would not affect homeowners’ monthly payments.

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1yr 2.44% (0.00%)
2yr 3.09%% (+ 0.05%)
3yr 2.90% (- 0.54%)
4yr 3.79% (0.00%)
5yr 3.69% (- 0.10%)
3yr variable closed (Prime – .75%) = 2.00%
5yr variable closed (Prime – .65%) = 2.10%

Although we still experience a decline in mortgage rates be prepared for the prime rate to go higher before the end of the year.

By early 2008, the Bank projects interest rates will increase another three-quarter points, bringing the overnight rate to 5.25. The current rate is now 4.5.

This is bad news for mortgage-holders, who have already seen lending rates rise in response to the increase this week. While longer-term fixed rates appear stable, those with floating-rate mortgages will start to feel the pinch in the coming months.

The average prime lending rate is currently 6.25 per cent.

The Bank of Canada expects to raise the key rate another three times by early 2008, to counter the unexpectedly high inflation experienced over the last few months, led by a rocketing performance by the loonie, which many expect will be on par with the US dollar by the end of the year.

Canada’s growing economy, bolstered by final consumer spending, is also spurring the Bank to take preventative measures.

However, a strong loonie also means fewer exports, which should take a bite out of inflation. In fact, the Bank expects inflation will be under control by 2009, with interest rates dropping accordingly.

More information on Canada’s economy in the near future is available in the Bank of Canada’s Monetary Policy Report, released July 12.