February 29, 2024

Managing Mortgage Renewals Amid High Interest Rates In Canada

In 2023, the Canadian economy experienced significant changes in two key economic parameters: inflation and interest rates. On an annual average basis, the consumer price index, which measures inflation rates, increased by 3.9%. The CPI started its upward trajectory during the pandemic, with 2022 experiencing a 40-year high inflation increase of 6.8%.

These factors will likely have a big impact on Canadians whose mortgages are up for renewal in the next few years.

How Mortgage Rates Have Changed In The Past Two Years

The Bank of Canada uses interest rates as a monetary tool to curb increasing inflation rates. As a result, interest rates skyrocketed from early 2022 to mid-2023, sending the mortgage and real estate industry into unexpected and expected outcomes.

Mortgage lending rates increased significantly, with homeowners closing mortgages with interest rates as high as 7% (over 7.5% with some alternative lenders). Mortgage activities by traditional financial institutions and alternative mortgage lenders were characterized by higher interest rates and reduced mortgage preapproval amounts on the borrower side.

Several years ago, mortgage rates were relatively low, with borrowers closing house purchases with rates as low as 1.5%-3%. What felt like a great deal is gradually coming to an end as a good number of Canadian mortgages come due in two to three years.

A recent Bank of Canada report showed that as of November 2023, about 45% of the mortgages initiated before the Bank of Canada started hiking interest rates had already seen increased mortgage costs, with the remaining 55% likely facing renewals with higher payments by the end of 2026.

Additionally, without precautionary steps, variable-rate mortgage holders with fixed payments should expect median mortgage payments to increase by 54% by the end of 2027 compared to payments around February 2022.

While many speculations center around the Bank of Canada not increasing interest rates, inflation rates are still relatively high to expect a decrease in the policy interest rate in early 2024. The policy interest rate currently stands at 5%, which the federal government has kept constant since July 2023. With the next interest rate announcement coming up on March 6, it is important to keep watch on which direction interest rates may take in the next few months.

Tips To Manage Mortgage Renewals At Higher Interest Rates

In 2025 and 2026, when many mortgages with five-year contract terms become due, Canadians will likely experience increases in mortgage costs due to renewals at higher interest rates compared to their existing low rates. Now, more than ever, homeowners need to start strategizing on the best ways to navigate potentially higher mortgage expenses. Here are some precautionary steps:

1. Shop for better mortgage rates.

Higher interest rates mean more of your payment goes toward interest and more money is spent on housing each month. To possibly have more disposable income, starting conversations with brokers or mortgage specialists before your mortgage term ends is important. This gives you more room for negotiating and shopping around for better mortgage rates.

2. Use debt refinancing and consolidation.

Consolidating personal loans and higher-interest debt such as credit card debt as part of a mortgage refinance can result in lower monthly payments and overall interest costs.

3. Reduce mortgage principal balance.

Most mortgage lenders allow lump-sum payments toward the mortgage principal or an increase in regular mortgage payments as a means to draw down the mortgage balance. This is usually specified in the mortgage contract.

Financial institutions generally determine the extra mortgage payments using percentages of the mortgage loan or specifying a fixed amount. Some lenders offer a 20/20 prepayment option, which means you can make a payment equal to 20% of the original balance annually and also increase your monthly payments by 20% to tackle your balance faster. Paying amounts higher than the specific amount can lead to mortgage penalties so it is important to confirm the privileges outlined in your mortgage with your mortgage broker or lender before making a prepayment.

By lowering the mortgage principal, you can reduce the impact of higher mortgage rates on your regular mortgage payments.

4. Budget for income and expenses.

The good old practice of budgeting can come in handy when trying to navigate higher mortgage payments. Finding ways to increase your income can help cushion an increase in mortgage rates and payments. Also, cutting back on expenses in flexible areas of your budget can help you rechannel funds to mortgage payments.

Key Takeaways

In two to three years, interest and mortgage rates may not be as high as they were in 2022 and 2023, but they are unlikely to be as low as they were during the 2020 and 2021 Covid-19 pandemic era. Canadians should expect to see more mortgage payments go toward interest than mortgage principals, and lower principal mortgage payment allocation results in building home equity at a slower rate.

Canadians with disposable income can drive down mortgage costs by drawing down their mortgage balances with additional payments. Consolidating debt and shopping around for lower mortgage rates can also help reduce mortgage interest costs.

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