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interest rates

What interest rates mean for your home purchase

If you’re contemplating jumping into the real estate market, either for your first home or for a new purchase, you’re probably hearing a lot of chatter about interest rates. 

“Oooh, be careful, rates are high right now!” 

“You might want to wait until rates come down.” 

“Can you get a better rate? That doesn’t sound like a great rate, they can do better.”

But what does any of this actually mean in real life?

We hear these questions so often that we felt it would be helpful to provide a short primer on how interest rates work, what they mean for your mortgage, and how it can impact your buying and selling decisions going into the 2024 real estate market. 

Interest rates 101

Interest rates are, in their simplest terms, a calculation of how much additional money (interest) you will owe as you pay back a loan. Lenders make their money from interest, whether you’re paying interest on a loan like a mortgage, or you’ve lent your money to the bank and you’re earning interest on your savings accounts or financial products. 

Interest rates are generally tied in large part to the rate of inflation – what the purchasing power of your dollar looks like. Low inflation rates are better for consumers because it means that the purchasing power of a dollar will stretch farther. Unfortunately, when there is more demand than supply in an economy, the inflation rate will rise, and so too will interest.

If you’ve heard a fair bit about interest rates in the news in the past few years, it’s because they have been newsworthy. In the early stages of the pandemic, with the economy in crisis mode, the government lowered interest rates to encourage borrowing and spending. The federal Bank of Canada had their base interest rate down to 0.5% in 2020, which led to a tremendous spike in home buying.

However, the landscape has now changed as inflation rates have risen. For most of 2023, the Bank of Canada has had their benchmark rate up to 5%, and economists predict that it will not lower significantly until late 2024 as the government waits for the economy to stabilize. However, even if it does lower, we are unlikely to see rates again that were as low as they were during the pandemic. 

How do mortgage rates tie in?

While the Bank of Canada sets a base interest rate, financial institutions such as the major banks set what is known as a ‘prime interest rate,’ which is interest rates that lenders will charge for loans such as mortgages, car loans, and home equity lines of credit. The prime interest rate is usually a few percentage points higher than the base interest rates so that the banks can earn money in the transaction. 

As we have written about previously, there are two prominent types of mortgages available – fixed rate, and variable rate mortgages. The mortgage may have an amortization period of 25 or 30 years, but borrowers typically set their rate agreements with lenders for a shorter period – frequently 5 years, but sometimes even shorter. A fixed rate mortgage means maintaining that same interest rate for those 5 years until they can renegotiate, whereas a variable rate fluctuates based on interest rates. 

Naturally, variable rate mortgages have gone through a significant shift in the past few years, where borrowers who made their purchase when rates were low are now stuck paying significantly more. For fixed-rate borrowers who got a great rate in 2020 or 2021, many may be fine next year but are already growing concerned about what their renewal rate may look like in 2025 or 2026. 

What it’s meant for the housing market

The reality of all of this is that higher mortgage payments have already put a strain on Canadian families and will be influencing their decisions about buying and selling. According to the Canadian Mortgage and Housing Corporation, the value of mortgages that will be renewed in 2024 and 2025 represent almost 40% of Canada’s gross domestic product. 

This means that borrowers are going to have to make difficult decisions, and many will be facing serious economic distress. This may result in less savings, less overall spending, or delaying major financial purchases such as a house. It also means that there will be a significant rise in mortgage defaults – those who simply cannot afford to pay off their mortgage.

When buyers put down less than 20% of the purchase price as a downpayment, they are required to have mortgage insurance that provides security for lenders. However, 75% of mortgages in Canada are uninsured, which will leave borrowers on the hook for repaying their loans, and struggling to secure a rate they can afford when it’s time for that renewal.

From a buying and selling perspective, these challenges in the economy will likely mean prospective buyers putting off any major moves until interest rates are lower, afraid that they’ll be unable to secure a favourable rate on a new purchase. Sellers may also shy away unless they’re looking to downsize, realizing that with the proceeds from their sale they will still be hard pressed to find something comparable with agreeable terms. 

When you’re pondering your next steps, you’ll want to consult the right real estate professionals – an experienced realtor, a bank or mortgage broker to get pre-qualified for a purchase, a home inspector to produce a report before buying, and of course a real estate lawyer. 

At Pavey Law, we’re proud to be part of your real estate team. Real estate lawyers are a core part of any transaction, and having an experienced lawyer on your team means that they’ll walk you through the process and are there for you if anything unexpected occurs. We’ve helped support thousands of clients throughout the Cambridge, Kitchener, and Waterloo region. Contact us today to set up a consultation.