Note: The week after this article was published, the Bank of Canada announced a further 0.50% rate cut in response to the COVID-19 virus. While the interest rate has changed, the information in this article is still relevant. For up to date, personalized advice, contact a mortgage broker near you.
This week, the Bank of Canada (BoC) announced it was cutting its target for the overnight rate by 0.50%, down to 1.25%. This was huge news, as the last time the Bank of Canada’s policy rate dropped by that much in a single rate cut was 11 years ago, during the financial crisis.
Why the big drop? Well, despite a strong start to the year, the global spread and impact of the coronavirus has made the Bank of Canada predict a weaker economy over the coming months. In order to adjust for the expected slowdown, the rate was cut.
In the wake of the BoC’s announcement, the Big Five banks (RBC, TD, BMO, Scotiabank, and CIBC) reduced their prime rates by the full 0.5%, passing the savings of the entire rate cut to borrowers.
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What the rate cut means for current homeowners
If you currently have a mortgage, how these rate cuts affect you will depend on the type of mortgage you have and whether or not you are coming up for renewal this year.
If you have a variable-rate mortgage
People with variable-rate mortgages are the big winners from this announcement. If your lender has cut its prime rate, your mortgage rate will also decrease. Your new rate will drop by the same amount your lender has dropped its prime rate (because your rate is calculated by its relation to prime.) For example, if your mortgage rate is set as Prime – 1%, your new rate will be the bank’s revised prime rate, minus 1%.
If you have a fixed-rate mortgage
People with fixed-rate mortgages aren’t so lucky. Because your mortgage rate is fixed for the duration of your mortgage term, your rate won’t change alongside your lender’s prime rate. However, you can comfort yourself with the knowledge that your monthly payments (and household budget) won’t be affected if rates go up in the future.
When prime rates go down, the tradeoff between the stability of a fixed rate and the savings reaped from a fluctuating variable rate becomes apparent.
If you’re close to renewal
If your mortgage is up for renewal, then you can benefit from the low rate environment we’re currently in. The Bank of Canada’s announcement has caused bond yields to further decrease, which means fixed mortgage rates will also decrease further, likely nearing the record lows of 2016.
The perfect time to renew a mortgage is when rates are low, but you’ll need to shop around to secure the best deal. Your lender will send (or has already sent) you a renewal notice, offering to automatically renew your mortgage quickly and easily.
However, the rate they offer you will probably be higher than what you can actually get. Instead of accepting the offer immediately, you should compare mortgage rates from other lenders and make sure you negotiate for the best rate. Getting the best mortgage rate can save you thousands of dollars, so it’s worth the effort.
What the rate cut means for aspiring homeowners
If you’re looking to buy a home, there are a couple of ways the rate cut might affect you.
If you’re a first-time home buyer
Major rate cuts are a mixed blessing for first-time home buyers. On one hand, mortgage rates are low, decreasing your cost of borrowing. However, these same low rates will increase demand in an already hot housing market. Be prepared for a lot of competition from other buyers.
The upcoming changes to the mortgage stress test will also add further fuel to the housing market blaze. Assuming the average mortgage rates in Canada will be 2.59% by the time the new stress test rules come into effect on April 6th, the stress test rate will become 4.59%, which is a full 0.6% lower than the current qualifying rate of 5.19%. This lower stress test rate will increase your buying power but also attract even more aspiring homeowners to the market, making competition even more fierce and driving home prices even higher.
Make sure you understand how higher home prices will affect the rates you can qualify for. If you have less than 20% saved up for your down payment, you can get the best rates but you will have to pay CMHC insurance. If the purchase price for your home is $1M or more, you will likely be unable to qualify for the lowest rates in the market.
The best thing for first-time home buyers to do right now is to speak to a mortgage professional for personalized advice.
If you’re a renter
As with most mortgage rate changes, renters will only be indirectly affected by this rate cut. A rise in home prices may not affect rent prices right away, but long term growth in home prices generally leads to higher rent.
The bottom line
Bank of Canada rate announcements come regularly, but cuts like these are few and far between. Coming at the start of the 2020 spring homebuying season, this major rate cut will cause fixed mortgage rates to approach the historic lows of 2016 and increase demand in an already red-hot housing market.
The best thing you can do is keep informed, frequently check mortgage rates, and stay up to date on any changes affecting mortgages in your province – Ratehub’s weekly newsletter is a good place to start.
If you’re due to renew, looking to buy a new home, or thinking about refinancing, speak to a mortgage broker to get some expert, obligation-free advice.