How do rising interest rates and inflation impact my mortgage?

The financial news these days isn’t good. In the wake of the COVID-19 pandemic and the onset of war in the Ukraine, most news about money has been bad. Between rising interest rates and accelerating inflation, it’s hard to know what to blame when costs rise, and affordable mortgages are harder to negotiate.

Mortgages are secured debt – but their interest rates may be variable

You don’t have to worry your mortgage will be cancelled, like a credit card can be (read the fine print!) if the finance company experiences tough times. Your mortgage is secured against collateral in the form of your home. The lender can feel secure, and so can you. Read more about secured debts in Bankruptcy Canada’s article, The Difference Between Secured Debt and Unsecured Debt.

Mortgages tend to be a predictable and manageable form of debt because they are long term. Also, many mortgages come with a fixed rate of interest. However, a borrower can often get a better initial rate of interest with a variable-rate mortgage; but – you guessed it – as inflation and interest rates rise, so will the monthly payment on a variable-rate mortgage.

What causes increased inflation?

Inflation means your dollar no longer buys as much as it used to. Normal market pressures tend to cause slow but steady rates of inflation, typically under two percent per year.

In Canada, inflation is tracked by the Consumer Price Index, or CPI. Canada’s average yearly inflation rate from 2010 to 2020 was 1.81 percent, but in 2021 it was 3.4 percent, and it is set to land at around six or seven percent in 2022, sparking reminiscences of the mid-1970s when inflation soared to over 10 percent.

What is causing our current elevated inflation rate? Much of it has to do with supply disruptions and higher production and shipping costs of goods and commodities. First the pandemic, and then the disruption in Europe, drastically changed the cost and efficiency of moving goods from place to place – causing consumer prices to rise.

Key to our rising inflation is the cost of fuel. We all noticed the price of gasoline jump as the Russia-Ukraine crisis deepened and trade sanctions cut supply chains and increased demands on resources. In our large country, we drive often, and over long distances – so a rising gas price impacts the average Canadian’s wallet significantly. Once again, the dollar does not buy as much as it used to, with monthly gasoline costs rising significantly as a result. That’s inflation.

How are interest rates related to inflation?

During the 1970s inflation crisis, and again in the early 1990s, the Bank of Canada and similar institutions in other countries learned by trial and error what measures they could take to slow inflation. A consensus developed that nudging interest rates upward will cool the market, increasing the cost of borrowing money, which then lowers demand and curbs inflation. Mortgage rates and home purchases are apt examples of this principle.

In Canada, the Bank of Canada has the power to adjust its key policy interest rate, which is the interest rate Canadian banks use for brief loans among themselves. This is also the rate on which the banks base their consumer lending rates.

The Bank of Canada’s interest rate, which had been stable between one percent and two percent for most of a decade, was lowered to 0.25 percent early in the pandemic to stimulate the economy. However, during the first half of 2022, the rate was raised sharply, in four increments, to 2.50 percent.

Since the beginning of 2022, the Bank of Canada’s interest rate has risen by 3.25 percent. It is natural consumer mortgage rates (and rates on variable interest products including some mortgages) will have risen at least that much, or in proportion with this change.

What will the result be? Since this interest rate increase was implemented, we have already seen a significant cooling of Canada’s housing market. Housing market areas where prices rose are now stabilizing because the higher cost of servicing higher-interest debt has forced a proportion of potential buyers out of the market, lowering demand.

The interest-rate hike will curb over-buying of housing and luxury items and keep those prices from rising due to reduced demand. But factors such as the rising cost of fuel imports will continue to affect our inflation rate.

The effect of higher interest rates on mortgages

Those of us who entered the housing market in the last 20 years have had a relatively easy ride – our mortgages have generally had interest rates ofseven7 percent or less – and for the younger, more recent homeowners, the rate has been well under four percent. Quite a difference from the early 1980s, when bank’s mortgage rates could be almost 20 percent.

Monetary policy analysts assure us that we aren’t heading back to the ‘80s, but today’s higher interest rates continue to have serious implications for consumer debt. The Bank of Canada’s policy rate increase has caused mortgage interest rates to rise by a similar two-to-three percent so far in 2022.

For a young person hoping to mortgage a new house purchase, this interest rate increase can be the difference between buying and not buying – or might result in a more modest house purchase.

For a consumer who is paying out a variable-rate mortgage, they will see their mortgage rate and their resulting monthly payment rising in tandem with the Bank of Canada’s rate. After our long period of stable or decreasing interest rates, a sudden increase in one’s monthly payment can come as a shock.

How about HELOCs and other credit products?

Similarly, the interest rates on home equity lines of credit (HELOCs) and many unsecured lines of credit and credit cards will rise as the Bank of Canada’s interest rate goes up.

For instance, if you are making payments on an interest-only basis, as is common with HELOCs, you may have seen your monthly payment almost double since the beginning of 2022. This is because your bank’s prime rate is closely linked to the Bank of Canada’s policy rate.

Similarly, unsecured lines of credit may be based on your bank’s prime rate. And lastly, rates on major credit cards are ultimately influenced by the prevailing consumer interest rates as well.

Higher bills can be a tipping point

Are you feeling the pressure of higher monthly bills? Here are signs your situation may be becoming serious:

• You find yourself using credit to buy basic necessities
• You frequently withdraw funds from one credit account to make payments into another
• You open new credit accounts seeking a better interest rate, but find yourself with a balance in both the new account and the one that you meant to replace
• You are losing sleep over your financial situation

If this sounds like you, don’t go any further down that road. It is time to take action.

Find help handling your debts

Take action while you still have options. When finances begin to feel tight, credit counselling or debt consolidation can often help but may not be enough to turn things around if matters become more serious. If you become insolvent, you can get debt relief and a better financial future through a consumer proposal (a formal debt-management option) or if your circumstances are particularly dire, a bankruptcy .

Licensed Insolvency Trustees (licensed by the federal government) are debt professionals; they will review your situation and recommend solutions to your financial difficulties. Licensed Insolvency Trustees are the only professionals who can file consumer proposals and bankruptcies for individuals.

Feeling squeezed? Call a Licensed Insolvency Trustee in your area and find out what options are available to you. The sooner you gain control over your debt, the sooner you’ll have peace of mind.