Todays mortgage rates are currently at historic lows, including the 5-year variable mortgage rate (which at the time of publication is available for 2.65%). Approximately one third of Canadians have a variable rate mortgage (according to the Canadian Association of Accredited Mortgage Professionals) because variable rates tend to be lower than fixed rates.
However, their disadvantage lies in their vulnerability to rate increases because they follow the prime rate. Since September 2010, the prime rate has been 3.00 per cent, which is well below the 10-year Bank of Canada average of 4.16 per cent.
But if the prime rate starts trending towards their historic norms in the near future, many variable mortgage holders would be affected by the rate increase. An increase in the prime rate would increase their regular mortgage payment. Assuming an interest rate hike, how many Canadians would struggle to make their mortgage payments?
As responsible home owners, it's in your best interest to verify your budget to see how a mortgage rate increase would affect your ability to meet your mortgage obligations. Would your finances still be stable or would you need to find additional income? This is an important question to consider. To verify your budget and mortgage you will need to use a mortgage payment calculator to determine what your mortgage payment is with a current interest rate and compare it against a higher interest rate.
Sample mortgage payment:
Let's say your mortgage amount is $400,000 with an amortization period of 25 years. The prime rate is currently 3.00 per cent, so with a 5-year variable rate of PRIME – 0.25, your mortgage rate is 2.75 per cent. Therefore, your current mortgage payment is $1,842 per month.
Hypothetical rate hike scenario:
The prime rate increases to 4.00% after 12 months. After one year, your remaining mortgage balance would be $388,692 with 24 years left on the amortization period. However, the new prime rate would be 4.00 per cent which would increase your mortgage rate of PRIME – 0.25to 3.7 per cent. Therefore, your new mortgage payment would be $2,043 per month. With a prime rate increase of 1.00%, your mortgage payment would increase by $201 per month.
The question you need to ask yourself is: Are you financially prepared to handle an additional $201 a month? If the payment increase leaves you feeling vulnerable, it means a rate increase could hamper your budget and you would either have to cut down on expenses or find additional sources of income to maintain your mortgage payments.
The best strategy to cope with possible rate hikes in the future is to treat your mortgage payment as if the interest rate was higher. Using the example above, you should have been paying $2,043 per month from the beginning, before the prime rate rose 1.00 per cent.
With this strategy, not only will you be fully prepared to handle a rate increase of 1.00 per cent, but you will also be paying down your mortgage debt faster!