Understanding How Rising Interest Rates Affect Toronto Real Estate

Friday, July 2022

The interest rate has a direct effect on affordability of home buyers and as a result impacts the real estate market. Your mortgage rate, or interest rate, is the percentage that your lender will charge for lending you money. Considering a simple example, if you were to borrow $100 at a 5% interest rate, your lender would charge an additional $5 to your outstanding balance each year.

In Canada, the Bank of Canada decides the overnight rate which is the rate at which banks can lend money. The prime rate is the annual interest rate Canada’s major financial institutions including banks use to set interest rates for variable loans and lines of credit, including variable-rate mortgages and investments. The prime rate varies with the Bank of Canada’s overnight rate.

The actual interest rates that consumers pay are dependent on the prime rate and vary with the borrower’s solvency as well as bank’s targets.

Why is interest rate rising now?

Canadians have been enjoying record low interest rates for years now. For example, even before the pandemic hit in 2020, BOC’s overnight rate was 1.25% and with covid-19, the overnight rate was drastically reduced to 0.25% to help the already troubled economy. Consequently, this led to lower mortgage rates of 1.5 to 2% and fuelled consumers to spend money during the pandemic and is one of the reasons why Toronto real estate market became so hot during the pandemic.

However, as people spent more money and with money being available so freely as well as global economic situations such as the Russia-Ukraine war, Canada experienced record high inflation which reached 8% in June 2022. To tackle inflation and curb people spending money freely, the Bank of Canada has made a series of interest hikes since March 2022 with the latest rise on 13th July 2022 2.5, with the Bank Rate at 2.75% and the deposit rate at 2.5%.

How Do Rising Interest Rates Impact Home Buyers?

• Interest rate hikes increase monthly mortgage costs. A 0.25% interest rate will mean an additional $13 per month for every $100,000 of mortgage.

• The interest rate affects the amount of money you can lend. Higher interest rates result in lower purchasing power as banks have strict rules. Your bank may have agreed to lend you $800,000 when interest rates were 2%, but at 4%, your home budget will for sure be reduced.

• Higher interest rates can fuel buyer activity. Potential homebuyers with mortgage pre-approvals at lower rates are motivated to buy before their rate guarantee expire. Also buyers may choose to buy now in case they fear higher interest rates in the future.

• Higher interest rates can reduce home prices but they also increase monthly costs. If you wait for home prices to fall before buying, be wary as you may have to end up paying more. If you are thinking of buying a home in the next 12 months, get a preapproval and lock into a lower mortgage rate as interest rates will not decrease anytime soon.

How Do Interest Rate Hikes Impact Home Sellers?

Although prior trend shows interest rate hikes in Toronto have fuelled temporary increased buying activity, the buying power of buyers is definitely reduced which can lead to price corrections in the housing market. We are definitely seeing a cooling period with houses staying in the market longer or fewer showings and bidding wars unlike the last few years of the pandemic. However with low inventory, home prices may not reduce as drastically as some buyers think and a real estate crash is far from imminent especially in locations like Toronto where demand is always there.

How Does Interest Rate Hikes Affect Home Owners?

You might think interest rate hikes will not affect you but in the long run it definitely will when it is time for mortgage renewal or depending on what type of mortgage you have – fixed or variable. When interest rates are higher, your monthly costs will go up when you renew the mortgage and some people may no longer be able to pay off those, and hence lose their homes.

Also in variable-rate mortgages the mortgage payment amount adjusts to the bank’s prime interest rate, so rising interest rates mean higher mortgage payments.

In case you have a fixed payment mortgage, your payment doesn’t fluctuate with interest rates, but the percentage of your mortgage payment that goes towards the principal on your mortgage payment will decrease. This means you are paying higher towards your interest and building less equity. This will definitely lengthen your total period to pay off your mortgage.

Most variable-rate mortgages have the option of converting to a fixed-rate. However, historically variable-rate mortgages have been lower but if you think interest rates will continue to increase at a high rate, you may consider changing to a fixed-rate mortgage.