Published: October 30th, 2021 • Last Updated: September 5th, 2022
Author: Ross Taylor on AskRoss.ca

With inflation in Canada at its highest levels in 18 years, talk has resumed about the prospect of higher mortgage interest rates much sooner than originally thought. And in fact, in recent weeks, five year fixed mortgage rates have already increased a couple of times. Let’s explore what higher mortgage rates will mean for your upcoming home purchases, mortgage renewals and refinances.

The Financial Post recently published an article where Scotiabank predicts eight (!!) hikes to the Bank of Canada Benchmark Rate between now and 2023. (Four in 2022 and another four in 2023.)

This sort of claim sells newspapers, and, who knows, it may turn out to be true. But we cannot take any predictions of higher rates and their timing as gospel. No one ever knows for sure.

Economists are famous for making bold predictions and then tweaking them as time passes so that, when we get to the date in question, their modified, tweaked forecast has been tempered to appear in line with what is actually happening.

As recently as last year, it seemed everyone was forecasting that there would be no rate hikes until at least the end of 2023. That was what the Bank of Canada told us in the early days of the pandemic. However, a few months ago, they tweaked that prediction and brought forward the threat of higher rates a full year earlier than initially anticipated.

Anyway, I have always been a cynic when it comes to rate forecasts. I am not saying they are wrong. Sure, rates could definitely start to increase. They have been sitting at incredibly, unnaturally low levels for years now. And inflationary pressures could be the tipping point.

Regardless, I feel we must make prudent decisions with our finances that take into account many different scenarios and plan accordingly.

What is the impact of Bank of Canada rate increases on mortgage rates?

If you already have a fixed-rate mortgage, nothing changes – at least not until your renewal date. At that time, you may be in for a surprise with higher payments than you currently enjoy. If this is something you want to get ahead of, you may want to consider some refinance options now, while rates are low.

If you are in a variable-rate mortgage, you will experience changes as they occur. In other words, every time the Prime Rate changes, this will affect the amount of interest you must pay on your mortgage. The majority of variable-rate mortgages see the payment adjusted as soon as there is a Prime Rate change.

Some lenders, however, offer variable-rate mortgages where the payment remains constant throughout the term of the mortgage. That can cushion the blow to your monthly cash flow – at least until your renewal date. In this scenario, where the payment remains the same, if rates rise, more money will go towards interest and less towards principal. The opposite is true, of course, when rates fall.

Do rising interest rates affect mortgage pre-approvals?

If you are pre-approved for a fixed-rate mortgage, you may find yourself in a very fortunate situation when rates start to increase because, as long as your mortgage funds within the 120 days your pre-approval is valid, your mortgage lender will honor your pre-approval rate!

Not long ago we saw clients lock in their purchases with pre-approved five-year fixed rates of 1.79% and 1.89%. This is fantastic because fixed rate mortgages have already risen twice of more since then. People without pre-approvals today are being approved somewhere between 2.29% and 2.84%. Things can change quickly with mortgage interest rates!

Is it worth getting a mortgage pre-approval for a variable-rate mortgage?

Yes, it absolutely is worthwhile. There are always a lot of questions around mortgage pre-approvals.

If you are pre-approved for a variable-rate mortgage, your payment will be affected by changes to the Prime Rate. This is something you cannot avoid.

BUT the rate for a variable-rate mortgage is expressed as a discount to the Prime Rate – and THAT is something that could change quickly during your pre-approval period.

Today, it is reasonably easy to get a variable-rate mortgage at 1.3%. With the bank’s Prime Rate sitting at 2.45%, your variable rate is expressed as Prime less 1.15%. (A discount from Prime of 1.15%.)

Your pre-approval will lock in that large discount of 1.15% regardless of whether the Prime Rate increases. In 2020 we saw a sudden and profound change to the discount for variable-rate mortgages in the early days of the pandemic. The discounts were actually gone and, if you wanted a new variable-rate mortgage, it would be at Prime or even higher!

Fortunately, this state did not last too long. In time, order was restored to the markets, and so were variable-rate discounts. But this experience proved it is also good to pre-approve a variable-rate mortgage.

Remember that you must qualify for a mortgage at the stress-test rate

The government first introduced the mortgage stress test a few years ago. Here is a reminder of how the mortgage test works.

The stress test is used to determine if a mortgage applicant would be able to manage their mortgage payment if their renewal interest rate was to increase by at least 2%. In fact, with variable mortgages today around 1.3%, these clients are being stress tested at 5.25%, which is a 400% increase in the rate!

What are the benefits of a mortgage pre-approval?

1. You have protection – or insurance – against higher rates developing during your 120 day pre-approval period. Let everyone else pay more than you, because your rate hold gave you every advantage with no disadvantages. If rates had fallen instead, you would be a free agent and could benefit from those lower rates.
   
2. You know your borrowing power. This is so essential when buying a home, in particular. One of the worst things you can do is fall in love with a home that is not within your budget. But if you do find yourself in that situation, you must consider other means to solve the problem – for example; you can source a bigger down payment or ask a family member to co-sign your mortgage application. There are lots of benefits to co-signing.
   
3. Your paperwork is already in order – When you are pre-approved, your credit has been checked, and your application and documents have been reviewed. (Not always, so please ask about this.) When you are out shopping with your real estate agent and find a property and you wish to make an offer, you can ask your mortgage broker to run the numbers and tell you if the math works for this specific property. The numbers can be run quickly because you already did a lot of the upfront work in order to secure your pre-approval.

The Takeaway

Many brokers and bankers do not go out of their way to offer mortgage pre-approvals. They feel it can be a waste of their time. After all, it is said only one in five pre-approvals actually fund with the lender who pre-approved them.

But, in my view, this is short-sighted. A mortgage pre-approval is totally worth the effort. We owe our home buying clients a mortgage pre-approval whenever possible. You can expect more people will jump on this bandwagon as soon as rates start to climb higher.

Mortgage Pre-approval – FAQs

Questions asked and answered in this article

Do rising interest rates affect mortgage pre-approvals?

In short – no, rising interest rates do not affect mortgage pre-approvals for fixed rates. Most lenders honour the pre-approved interest rate for up to 120 days. Therefore, if you receive a pre-approved rate of 2.09% and the lender’s rate has since increased to 2.59% (for example) you’ll still be able to use your 2.09% rate.

What are the benefits of a mortgage pre-approval?

There are three benefits to a mortgage pre-approval. 1) You have protection and insurance against higher interest rates. 2) You’ll understand your borrowing power and therefore know how much more you may need to borrow, or how much you can spend. 3) You’ve already organized all of your relevant paperwork needed for a mortgage application. Your mortgage broker can assess specific properties for you very easily now.

Is it worth getting a mortgage pre-approval for a variable-rate mortgage?

Getting a mortgage pre-approval for a variable-rate mortgage is definitely worthwhile. Similar to fixed-rate mortgages, if you are pre-approved with a variable-rate, you end up protecting your discount from the Prime Rate. Currently, these pre-approval discounts are quite large (1% to 1.3%) but they can change quickly and dramatically.