On July 13th the Bank of Canada announced an interest rate hike of 1%, making it the largest increase since 1998, bringing the overall prime rate to 4.7%. And for Canadians with variable mortgage rates, this could mean not paying down your principal as quickly as you originally planned.
In order to keep your mortgage payments on track, we recommend following the 1% rule and increasing your monthly payments 1% for every 0.25% increase to the prime rate. Here’s how these increases impact your mortgage, and what the 1% rule looks like in practice.
How will rising interest rates impact my mortgage?
The most immediate impact from rising interest rates can be seen in any variable rate product such as a line of credit or a mortgage. For someone who owes $100,000 on one of these products, a 25 basis point increase in interest rates translates to a $250 annual increase in borrowing costs.
With forecasts ranging from 50 to 150 basis points expected increases over the next 18 months that same borrower could face $40 to $120 increase in monthly interest charges. For the borrower, that means either coming up with additional funds every month, or in the case of a mortgage not paying down your principal as quickly as you would at lower interest rates.
*This is just an interest calculation that does not include principal payments
In order to keep your mortgage payments on track, we recommend following the 1% rule and increasing your monthly payments 1% for every 0.25% increase to the prime rate.
What is the 1% rule?
The 1% rule isn’t an exact calculation, it’s a general rule of thumb that gives us a good idea of how much we should increase our loan payments to keep up with increasing prime rates. As we stated in the intro, the typical suggestion is to increase monthly payments 1% for every 0.25% increase to the prime rate. If we take the most recent 1% increase into account that occurred on July 13th, and apply it to an example of someone who pays $3,000 per month towards their mortgage, the 1% rule indicates that this individual should increase their payment by $30 for every 25 basis point increase. Given that the 1% increase raised the prime rate by 25 basis points 4 times (100 divided by 25) we recommend increasing your payment by $120 per month ($30 x 4).
It’s also important to note here that if you don’t make any increases to your monthly payments, and prime rates keep increasing, your payments may eventually not be enough to cover the interest on your loan. When this happens, your payments will automatically be adjusted by your lender, so we recommend being proactive and getting ahead of these auto-adjusted rates.
What else can I do to stay on track?
By doing the following, you can feel confident that changes to your mortgage rate won’t interfere with your long-term financial plans:
- If you have a variable rate mortgage, consider increasing your payments. As interest rates climb, less is paid towards the principal, and more towards the interest, on variable rate mortgages. Left unchecked, rate increases can leave you owing more at the end of your mortgage term than you initially intended.
- Consider the benefits of a fixed-rate mortgage. They offer consistent interest rates that will remain unchanged for the duration of the term, and peace of mind from knowing that big market movements won’t upset your homeownership plans.
- It’s worth spending time with your lender to evaluate the variable market cycle. It’s always better to make a conscious decision to do nothing, rather than making no decision at all. If you can afford it, it may be beneficial to increase your payments to ensure a lower renewal rate. Your payments could increase on a higher principal than you’re expecting, and not altering your monthly payments could have long term implications to the total amount of interest you pay over time. Long story short: if you don’t increase your monthly mortgage payments, you could be looking at a longer repayment timeline than you originally thought.
How else could these interest rate increases impact my money?
How do rate increases affect my everyday accounts and how can I prepare?
Here are some basic tips for adjusting to the interest rate increase:
- Take some time to review the types of accounts you have, and how they fit into your overall financial plan.
- Make sure you understand how your line of credit or mortgage works.
- Be prepared to pay more than your currently monthly amount on your line of credit going forward.
In short, you will need to begin budgeting and preparing to pay more on credit cards, lines of credit, and loans.
We’re here to help.
If you’re still unclear what this could all mean for you, connect with one of our advisors. We’re on standby to help you make sense of these rate hikes and feel confident about your finances. Call us at 1.888.517.7000 or book an appointment online.
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This article is provided for general information purposes only. It is not to be relied upon as financial, tax, or investment advice or guarantees about the future, nor should it be considered a recommendation to buy or sell. Information contained in this article, including information relating to interest rates, market conditions, tax rules, fees, and other investment factors are subject to change without notice, and Coast Capital Savings Federal Credit Union is not responsible for updating this information. All third-party sources are believed to be accurate and reliable as of the date of publication and Coast Capital Savings Federal Credit Union does not guarantee the accuracy or reliability of such sources. Readers should consult their own professional advisor for specific financial, investment, and/or tax advice tailored to their needs to ensure that individual circumstances are considered properly and action is taken based on the latest available information.