If you’re a homeowner, hoping to buy a home, or pay attention to the real estate market at all, you know we’ve been living through some of the lowest interest rates on record. COVID-19 has caused drastic decreases in rates to keep the economy moving while we recover from the pandemic. However, there has been talk in recent months about what will happen if, and when, mortgage rates change. It’s largely expected we will see some changes from the Bank of Canada in 2022. How will these changes affect your mortgage? Here’s what you should know about the overnight rate and prime rate, and how mortgage rates change alongside them.

The key rates

The overnight rate

The overnight rate is a big part of the Bank of Canada’s rate watch announcements. This means it has a huge impact on mortgage rates. In its most basic form, the Bank of Canada sets the target for the overnight rate based on things like inflation and economic performance in Canada. Major financial institutions and banks borrow and lend at the overnight rate, which impacts interest rates on mortgages. Right now, the overnight rate sits at 0.25 per cent, where it has been since its emergency drop from 0.75 per cent in March 2020 as the pandemic hit Canada’s economy. This means major institutions are currently borrowing at this rate.

The overnight rate rises when the economy needs to slow inflation, and make borrowing and spending more expensive. It lowers when the economy needs a boost, and the low rates encourage more spending and borrowing. The overnight rate is low today to minimize the impact of COVID-19 and to keep Canada’s economy moving.

The prime rate

A different but closely related term is the prime rate. Major banking institutions use the prime rate to determine what their lending rates should be for variable products. The Bank of Canada sets the overnight rate, which then usually prompts banks and lenders to change their prime rates accordingly. 

The prime rate impacts variable-rate mortgages because it represents the interest rate on that mortgage. Right now, the prime rate (for most lenders) is 2.45 per cent, meaning borrowers pay 2.45 per cent interest on variable-rate mortgages with any adjustment factor that is offered by the lender. In early 2020, the prime rate sat at 3.95 per cent before the overnight rate experienced its major drop, prompting the prime rate to do the same. Rates have been low ever since, as we have been regaining our footing in the Canadian economy. When variable mortgage rates change, it will be due to changes to the prime rate.

What to expect in 2022

Back in October, the Bank of Canada announced Canadians should expect the overnight rate to increase in 2022, likely within the first half of the year. As the economy continues to recover from COVID-19, the bank is in a better position to increase rates to maintain control of inflation. Predictions for the exact increase vary, but some are expecting to see an overnight rate of close to one per cent by the end of next year, perhaps moving towards three per cent by the end of 2023. As a result, the prime rate is bound to increase as well. This means variable-rate mortgages will become more expensive in 2022 as borrowers will be paying higher interest rates on these products. 

As for fixed-rate mortgages, they aren’t impacted by the prime rate in the same way. We know fixed-rate products don’t change during a mortgage term even if rates increase or decrease. However, fixed-rate mortgages are tied to the bond market, and bond yields are also likely to keep rising. This means the rate borrowers lock into if they opt to convert their variable rate mortgage to a fixed-rate mortgage will increase throughout 2022.

How to prepare for the market

If you’re hoping to buy a home in 2022, you may be doing so amidst a change in interest rates. If you buy while rates are still low, you will enjoy lower interest rates on your mortgage.  Again, if you have a variable-rate product, your monthly payments will increase when rates increase. However, these low rates have driven demand to insane levels, meaning you will have lots of competition during your housing search. 

On the other hand, buying after a rate increase means that interest rates will be higher, but you may be dealing with less competition, and therefore, price increases might not be as steep. There’s no guarantee when rates will change, so it’s important to be ready for either scenario. No matter what, the key is to prepare yourself as best as possible ahead of time. Be sure you have a down payment saved up, a clear understanding of your budget, and a high credit score to secure the best products. If you haven’t been pre-qualified for a mortgage, now is the time to do so. You can also get in touch with a broker to discuss whether you’re a better fit for a fixed-rate mortgage or a variable-rate mortgage.

If, and when, mortgage rates change in 2022, it will certainly cause some waves in the market. However, it’s important to remember that rising interest rates are essential for the continued recovery of our economy post-COVID-19. Even though this change can be stressful, mortgage professionals like myself are here to guide you.

If you have questions about your mortgage or buying a home, get in touch with me!