On June 5th, the Bank of Canada (BOC) announced a 25 basis point cut to its key overnight lending rate, lowering it to 4.75%. The welcomed decrease was the Bank’s first rate cut since March 2020 and followed a period of intense monetary policy tightening and maintenance, where, between March 2022 and July 2023, the Bank of Canada raised interest rates ten times.
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James Laird, Co-CEO of Ratehub.ca and President of CanWise mortgage lender explained that we are now in the fourth phase of the pandemic rate policy. “Phase 1 was dropping rates super aggressively; Phase 2 was increasing them dramatically to fight inflation; Phase 3 was keeping them elevated to tamp down inflation; Phase 4 is to move to a less restrictive rate policy.”
Addressing the question on everyone’s mind: “Usually if there’s one rate cut, more will follow,” Laird says. “Now, Canadians will be wondering where the Bank wants to get to and when, which will be exciting if you are a borrower.”
What is a Variable-Rate Mortgage?
A variable-rate mortgage has an interest rate that can change over time, depending on the prime rate. The prime rate is a baseline interest rate set by banks, and each lender will add a certain percentage to this rate. Variable-rate mortgages are ideal for those who can handle risk and appreciate budget flexibility. Additionally, they may enable you to pay off your mortgage faster.
For example, imagine you have a variable-rate mortgage with an interest rate set at prime minus 0.5%. If the current prime rate is 4.0%, your mortgage rate will be 3.5%. Here’s how changes in the prime rate affect your mortgage.
- If the prime rate rises to 4.5%: Your mortgage rate increases to 4.0%, resulting in higher interest payments.
- If the prime rate drops to 3.5%: Your mortgage rate decreases to 3.0%, resulting in lower interest payments.
Meanwhile, a fixed-rate mortgage keeps the same interest rate throughout the entire loan term. For example, if you have a five-year fixed-rate mortgage at 4.79%, you will pay 4.79% interest for the full five years.
This guaranteed stability gives borrowers the peace of mind that their mortgage payments will not change, even if interest rates in the market fluctuate. However, once the five-year term ends, the borrower will need to renegotiate their mortgage.
The key difference is that in variable-rate mortgages, interest rates can change based on the prime rate, causing your monthly payments to increase or decrease. In comparison, fixed-rate mortgages have interest rates that stay the same for the loan term, providing stability in monthly payments but requiring renegotiation at the end of the term.
How Rate Fluctuations Affect Your 5-Year Variable Mortgage Term
Since variable-rate mortgage holders are immediately impacted by changes in interest rates, Zoocasa has calculated the average monthly mortgage payment on a 5-year variable following the rate cut. Benchmark prices are from the Canadian Real Estate Association. Total mortgage amount accounts for a 10% down payment for any benchmark price under $1M, and a 20% down payment for benchmark prices over $1M. Average monthly payments were determined using the total mortgage amount, which is the benchmark price minus the down payment.
Highlighting major Canadian cities like Toronto, payments are projected to decrease by approximately $155 per month, resulting in an annual savings of around $1,860 for homeowners.
Meanwhile, in Vancouver, the average monthly change between different interest rates is $166.20, resulting in annual savings of over $1,994. In contrast, Regina, the most affordable city, has an average monthly change of $75.60 between different interest rates of $907. Should further rate cuts be implemented, mortgage holders could increase their savings or even pay their mortgage down faster.
Falling Rates Could Revive Housing Market
After all, high borrowing costs can be a major deterrent for buyers and sellers alike. A 2024 Zoocasa survey of 1,577 people across the US and Canada found that 51% of non-homeowners cited high home prices as the main reason for not purchasing a home, despite their aspirations of homeownership.
If lending rates continue to drop, the real estate market is likely to see significant changes.
“With lower lending rates, prospective buyers will be motivated to get off the sidelines, ultimately leading to more sales activity and the potential for an increase in prices. Now is an excellent time to get off the sidelines, before the competition gets too fierce, explore your options and take advantage of the greater negotiating power you have with the current surge in inventory,” explains Carrie Lysenko, Zoocasa CEO.
The BOC’s next announcement is scheduled for July 24, 2024.