With little fanfare, on Monday June 10 TD Canada Trust issued a short press release announcing that the interest rate on a five year closed mortgage was increasing from 3.09% to 3.29%.
Your reaction is probably “so what?” An increase of .20% is no big deal, right? That may appear to be a small number, but here’s what it means in real life:
If you have a $200,000 mortgage, amortized over 25 years, at 3.09%, your monthly mortgage payment would be $955.75 per month. Over the course of 25 years, if the interest rate remains unchanged, you would pay $286,725 to pay off your mortgage.
That same $200,000 mortgage at 3.29% would cost you $976.50 per month, so over 25 years you would pay a total of $292,950.
In simple terms, an extra one fifth of one percentage point of interest will cost you $6,225 over the life of your mortgage. That little increase in interest can cost you a lot.
My point is not to criticize TD Canada Trust. There are many different mortgage lenders in Canada, so you as a customer can choose to borrow from whomever you want. If one bank is increasing interest rates, it is quite likely that other lenders will also increase rates in the future, and your bank might be next to increase rates.
My point is to suggest that you consider what an increase in interest rates will do to your personal cash flow.
For many years the best decision a Canadian could make was to get a variable rate mortgage (not a fixed rate), because the rate was lower. That’s great, but a variable rate, obviously, is variable, so it can go down, but it can also go up.
Today you may be paying 3% on your variable rate mortgage, so on a $200,000 mortgage amortized over 25 years you are making a monthly payment of $946.40 What happens if your variable interest rate was to increase by 1%? Again, you may not think 1% is a big number, but a 4% interest rate on your $200,000 mortgage amortized over 25 years would cost you $1,052.04 per month. Can you afford to pay an extra $105.55 per month on your mortgage? Will your after tax pay cheque be increasing by $105 per month this year? If not, higher interest rates will squeeze your budget.
Here’s where most people miss the point: going from a 3% to 4% interest is not an increase of 1% in your payments. If your rent goes from $300 to $400 per month, how much did your rent increase? Answer: one third, or over 33%.
That’s the point: if your interest rate increases by 1%, the actual cost of your mortgage in the example above increased by over 33%.
That’s a huge increase, and unless your pay will also be going up by 33%, higher interest rates will be a problem for your monthly cash flow.
Here’s my advice: don’t assume interest rates will stay low forever. If one bank has started increasing rates, it’s likely that other banks will follow, so now is the time to consider what you will do if interest rates increase, and make a plan NOW to deal with a potential rate increase.
If your income in not stable, or if you plan to move, perhaps now is the time to consider selling and renting to protect yourself.
If you plan to live in your current house for many more years and you have a stable income, perhaps now is the time to switch from a variable rate to a locked in fixed rate. You may also want to consider shortening the amortization period on your mortgage to pay it off sooner, or switching from monthly to bi-weekly or weekly payments (if you get paid bi-weekly or weekly) to accelerate your payments and become mortgage free faster.
I can’t predict the future so I don’t know when, or if, interest rates will increase, but I can advise you to consider all options, so that you are prepared regardless of what happens to interest rates.