What Does Inflation And Rising Interest Rates Mean For Real Estate?

There's been a lot of noise recently about inflation and interest rate hikes. If you're confused and concerned, you're not alone, and we're here to help you understand what it all means – and how it might impact real estate in Toronto, your plans for homeownership, and your monthly budget. 

Inflation: The Basics

The inflation rate is measured by the Consumer Price Index (CPI), which looks at how much prices for food, shelter, clothing, transportation and other items go up over time. For the last couple of decades, inflation rates have held steady at around 1- 3% a year. But lately, that has changed. In the last couple of months, prices have gone up by 7-7.5%. 

Why is it happening? Well, there's been a lot going on in the world lately. The pandemic did a number on the supply chain (anyone who has tried to buy a car recently will know what we mean…), the war in Ukraine is causing economic and political uncertainty, and we've really stepped up our spending post-COVID. 

The best way for the government to combat inflation is to encourage people to NOT spend their money. By bumping up interest rates, they make it more attractive to sock our money away – and spend less of it, thereby slowing inflation. For example, right now, Simplii is advertising a 4.75% rate for their high-interest account – way higher than anything they’ve offered in recent memory. That’s some serious incentive to save rather than spend. Higher interest rates also mean it costs more to borrow money. Making it harder to borrow means people will buy less – and that includes real estate. 

Interest Rates: What You Need To Know

Don’t have a clean picture of how lending rates are determined? Here’s a quick breakdown: 
 

• The overnight rate is set by the Bank of Canada. It’s the rate banks use when they lend money to each other. Right now, the overnight rate is 3.25%. 
• The prime rate is based on the overnight rate, but is higher. It’s the foundation for the interest lenders charge consumers, and is set by individual banks. Right now, the prime rate set by major lenders is 5.45%. 
• The actual interest rate lenders charge for mortgages is tied to the prime rate, but varies depending on what kind of mortgage you get (fixed-rate mortgages are always higher than variable-rate ones), your credit rating – and even whether the bank is focused on attracting borrowers or investors. It’s always a good idea to shop around, or better yet, to use a mortgage broker to help you find the best product for your needs. 

Why has the Bank of Canada raised interest rates so much? 

Canada’s interest rates have been pretty low for years, hovering around 1.25% just before the pandemic. When COVID hit, people stopped spending due to job loss, uncertainty, and the fact that dining, shopping, travel and entertainment were off the table. To encourage spending, the government dropped the overnight rate to a historically low 0.25%. And it worked: the ultra-low rates kickstarted the housing market, among other things, and the result was the overheated real estate bonanza that lasted until around April, when rates started going back up to slow down inflation. 

Since the first 0.5% increase in April, there have been several more bumps that have brought the overnight rate to 3.25% – a 3% increase over 6 months, with the potential for more increases on the horizon. 

What do those numbers mean in dollars and cents?

Every 1% increase means you’ll pay about $54 more a month per $100K owed – and 3% means $162 more per 100K. On a $700K mortgage, that’s $1,134 more each month. Big difference. 

What does it all mean for the housing market and affordability? 

As interest rates go up, property prices tend to drop. But higher rates can offset lower selling prices, making monthly carrying costs higher, despite the lower initial price tag. That impacts buyers, of course, but it also has repercussions for homeowners. How much you’re affected by rising rates depends on what kind of mortgage you have.

If you have a fixed-rate mortgage, your monthly payments won’t change until the end of the loan term (commonly 5 years). If you locked in before the BoC started raising rates, you’re in good shape until you have to renew – at that point, you’ll be subject to whatever the current rate is. You pay a premium for stability here: fixed-rate products come with substantially higher interest rates than variable ones. 

If you have a variable-rate mortgage with payments that fluctuate with the posted rate, increases mean your monthly payments go up. 

If you have a variable-rate loan with fixed payments, your monthly outlay won’t change, but more of the payment will go towards interest and less towards principal, which will extend your loan and mean you pay more interest overall. And if the rates go up enough that your payments no longer cover the interest and the principal (which is happening more these days), your lender will likely want you to increase your payments. Talk to your lender or a financial advisor to figure out the best options for your situation. 

But remember this: what’s happening now is exactly why there’s a stress test when you first apply for a mortgage – it ensures you can still afford payments, even at higher interest rates. 

Trying to decide if now is the right time to buy? Rates are up but prices are down. And there’s way less competition out there. We’re happy to sit down with you to talk about your options – get in touch anytime!