The Bank of Canada announced an increase to the overnight rate by 0.50% on June 1st, 2022, taking the overnight rate to 1.50% in a decision that was widely expected by most economists. The announcement is the third rate increase for 2022 and brings the overnight rate almost back to pre-pandemic levels, where it was 1.75% before the pandemic took rates to historic lows of 0.25%.
Some highlights from the announcement:
- Inflation has been largely driven by higher prices for food and energy. CPI inflation reached 6.8% for the month of April, well above its forecast and “will likely move even higher in the near term before beginning to ease.”
- Almost 70% of CPI categories now show inflation above 3%
- The increase in global inflation is occurring as the global economy slows.
- The Russian invasion of Ukraine, China’s COVID-related lockdowns, and ongoing supply disruptions are all weighing on activity and boosting inflation.
- The war has increased uncertainty, is putting further upward pressure on energy and agricultural commodities prices and “dampening the outlook, particularly in Europe.”
- Canadian economic activity is strong with 1st quarter GDP growth of 3.10% for 2022.
- Job vacancies are elevated, with some companies reporting “widespread” labour shortages.
- Consumer spending remains robust and growth in the 2nd quarter to remain strong.
?What this means for consumers
The overnight rate increase will impact loans linked to prime, which for the most part, will increase to 3.70% (up from 3.20%). Typically variable rate mortgages and HELOC (home equity lines of credit), lines of credit will all be impacted by an increase to prime.
Looking beyond the headlines
It’s important to pay attention to all the available data as it’s easy to get carried away with “click-bait” headlines.
Most of the media has focused on the significant drop in real estate transactions for most of 2022 and presented some doomsday scenarios of a “significant” real estate market correction, but the data proves otherwise.
On average real estate transactions are down in Canada at about 26% with the end of April 2022 data. However, home values are still up on average 7% in Canada, with larger markets like Toronto at 15% and Vancouver at 19% year over year.
Many home buyer clients have noted that they are waiting for additional rate increases in anticipation of discounted home values. Still, many industry experts see homes appreciating further by the end of 2022, with a Royal LePage study forecasting 16.5% growth for GTA, 15% for Vancouver and 7% in Regina.
Waiting to find the perfect home could ultimately end up costing more as demand is still strong for housing across the country and Canadians are sitting on a record savings of 8.1% (compared to an average of 3.50% the last decade), but the recent rate increases have certainly forced buyers to reassess their budgets and play a waiting game until they feel the market has stabilized further.
Strategies to consider in a rate increasing environment
A traditional mortgage may not be the best solution in the current economic environment, especially since both fixed and variable rates have increased quite a bit in the last few months. Here are some alternatives we’ve been presenting to our clients:
1. Consider a HELOC (home equity line of credit) for most if not all
of your lending needs:
On a $1MM purchase, the maximum lending is 80% or $800,000. With a HELOC you can have up to 65% of the purchase price ($650,000), with the difference of $150,000 being a mortgage.
· In this example, your total monthly payment would be $2,950 compared to a regular mortgage on an $800,000 balance of $3,600.
· This solution provides significantly improved cash flow as HELOCs require interest-only payments, which could be very useful as we continue to see rates rise.
· HELOCs are also fully open, which means that you can lock in any time or
wait until rates are more favourable to revisit all your lending options.
· Keep in mind that the HELOC solution only requires interest payment so no actual principal is paid down, but this could be a very attractive short-term solution in the current market.
2. ?Short-term fixed pricing:
· With average fixed rates getting close to 5% and the Bank of Canada looking to get inflation under control, we will likely see a higher rate environment for the next 18-24 months until inflation is under control and rates come down.
· In an effort to provide a fixed payment and mitigate future rate increases, a 1-2 year fixed term is ideal to weather the current environment and put you in a position to revisit all
options when you’re up for renewal, ideally in a more favourable rate environment.
With inflation near 7% in Canada and some uncertainty regarding future rate increases on the horizon, it’s safe to say that we’re in for a bit of a roller coaster ride. Most economists forecast another 0.50-1.00% in potential additional increases by 2023. Most of these increases will be required to bring inflation down to the Bank of Canada’s target range of 2-3%, so clients should “stress test” their budgets to account for these possible increases.
The good news is that Canada is still well-positioned compared to some of our G7 peers who are seeing 9% inflation (UK), 8.3% (US) and 7.8% in (Germany).
With the Sarwar Team having a network of top mortgage specialists working with over 60 lenders across the country and some unique lending offerings, now is the best time to complete an annual mortgage review or pre-position yourself for any future lending and your next move.