Variable Mortgages Triggered After September Interest Rate Hike
If you got into a variable mortgage when interest rates were at their lowest, you’re probably going to be hearing from the banks soon because monthly payments are going up after September’s rate hike of 75 basis points, now sitting at 3.25%.
RBC tells us that they have approximately 80,000 variable mortgages that will be affected in the next couple of months, so if there are six big banks out there, and four of the six big banks offer these types of mortgages with trigger rates, then we’re looking at at least 320,000 variable mortgages where payments will start to go up.
So in this video, let’s take a deeper dive into how rising interest rates will affect existing home owners in Toronto.
What Is A Trigger Rate?
Every time you pay your monthly mortgage payment, there’s a portion that is interest and another portion that pays down your loan. When interest rates go up, this principal portion can act as a buffer for your variable mortgage. What this means is that even if interest rates continue to go up, some banks with variable mortgages will reduce the principal paydown and increase your interest to keep your monthly payment the same.
But of course, this is only possible up to a certain point. If interest rates go up too much, the principal paydown buffer might not be enough to cover the extra interest, and so your monthly payments will have to start coming up. The rate at which these payments will start coming up is called the trigger rate, and this is starting to happen after our latest September rate hike, and those most affected will be those who got mortgages at interest rate lows.
How Much Will Variable Mortgages With Trigger Rates Go Up By?
Let’s go through an example. Say you got a mortgage 9 months ago, when the prime rate was at 2.45% with a discount of 0.7%. This means your trigger rate will hit when the prime rate goes over 5%.
The prime rate is now at 5.45%, and so it’s clear that mortgage payments will start going up. We know that rates are going to keep going up, so let’s see how much more you might have to pay at the peak. Bank forecasts expect the target rate to go to around 3.5% at the peak, taking the prime rate to 5.7%, so at that point, your monthly payment will be $400 more than what you started with on an $800,000 mortgage.
The trigger rate might also impact other variable mortgages too. Those who got in after the March rate hike will see a $320 increase in variable payments if the prime rate goes to 5.7%, those who got in during April will see a $125 increase, and only those that got a mortgage after that won’t be affected. So let’s think about this.
A $400 increase is not insignificant, but when we buy freehold investments, we typically look for a few hundred dollars of positive cash flow at the start, just in case. So, in this case, the positive cash flows will help to absorb much of the impact, if not all of it.
Condo investors are in a different boat because their cash flow is negative to begin with, and so an increase in mortgage payments will definitely make their holding power even weaker. And obviously, end-user home owners will see weaker holding power too, because these added costs also need to come out of pocket.
Increase In Payments On Mortgage Renewal
Besides trigger rates, mortgage holders who are up for renewals soon might also run into trouble. According to BMO, they see $14 billion in uninsured mortgages up for renewal over the next 12 months. If you multiply that by six big banks, you’re looking at $84 billion that might be impacted.
Most mortgages are on a five-year term. According to Ratehub’s discounted 5 year fixed rates, the current best fixed rates now are at 4.24%, and in 2018 it was at 3.19%, so there’s a bit over a 1% difference here. This means the bigger damage will be on the variable side, because variable rates in 2018 were at 2.25% and in contrast, these rates might go up much more to 5% soon.
But remember: rates have gone up, there’s 5 years less in your amortization period, and your loan amount has decreased too. So there is a bit more flexibility here to drop monthly payments if the amortization period gets extended back up again. And if you do that, the monthly payment on an initial $800,000 mortgage might go up by a lesser $700.
That’s still a big jump for end users and condo investors alike – but in this case, condo investors will be better off than end users here because rents have come up since 2018, which improves cash flow. Again, freehold investors will be the least impacted because they have positive cash flow to begin with and rents have gone up too, which gives a bigger buffer to cover the increase in mortgage costs.
So if we look at the big picture, here are a few takeaways. Over time, cash flows are key for strong holding power, and investors will have an edge over end users.
Then within the investor pool, multi-family homes have better cash flows compared to single-family homes, which do better than condos. And finally, time in the market is another factor that can improve holding power. Over time, your loan amount drops, and you’ll have more flexibility to lower your mortgage payment amounts by extending your amortization period.
At the end of the day, markets with better holding power will mean more price stability in the upcoming months, and unfortunately, condos and markets with more end-user homes will likely see bigger drops in the coming months.
How We Can Help
if you’re thinking about buying the real estate dip and you want to understand more about what’s happening in Toronto real estate, we’re happy to chat. We’re a real estate sales brokerage that focuses on investing in freeholds in core Toronto, so we can help you see things more clearly and match you up with the best investment property for you.
After we help you buy it, our team also provides renovation guidance, leasing and property management if you need it. So, just connect with us if you want to learn more about our services!
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