We’ve all been enjoying record low interest rates. The low mortgage rates have enabled us to buy bigger homes or just pay less interest each month. If you’re one of the many Canadians who’ve taken on a bigger mortgage then you may be concerned about rising rates. And rise they will. Current mortgage rates tied to the prime lending rate have been strategically held low to help stimulate the economy. Historically speaking the prime rate in a healthy economy runs somewhere between 5% and 6%. Although there’s an argument to be made for a new norm going forward, you should be prepared for at least a 1% increase in your mortgage rate sometime over the next 3 years.
If you have a $300,000 mortgage with a 25 year amortization at the current prime rate of 3.0% then your mortgage payment would be $1,420 per month. It’s common practice for the Bank of Canada (BOC) to raise the prime rate in 0.25% increments. A .25% would raise your monthly payment by $39 to $1,459 per month. A full 1.0% increase in the prime rate would increase your monthly mortgage payment by $158 to $1,578 per month. While this is not a fun scenario for anyone, it is by no means the end of the world and could be absorbed by almost all borrowers.
Now let’s look at a worst case scenario of doom and gloom for variable mortgage rate borrowers. What if the prime interest rate jumped by 2.5% to its historical norm of 5.5%. In this scenario your $1,420 monthly payment would jump to $1,831, a $411 monthly increase. For a family with a tight budget, this could be a significant financial challenge. If managed property, however it won’t lead the sale of your family’s home. There are often alternative solutions to once again lower your monthly payment. Examine your options now, and you’ll be prepared for the worst the economy can dish out.