If you’re looking to buy a home or already have one, you may have noticed that mortgage interest rates have been going up over the past year.

As you are probably aware, the cost of living has increased because of inflation. Everything seems to be more expensive including gas, groceries, and housing costs.

As inflation increases, the cost of your mortgage will also rise. To understand how this happens and what you can do about it, let’s take a closer look at inflation’s impact on mortgage expenses.

How Does Inflation Work?

Inflation is a measure of the increase in prices over time. When inflation is low, it can be good for the economy and spur economic growth, because it increases economic growth by encouraging consumers and companies to spend more money. But when inflation rises too fast, it has the opposite effect. Consumers tend to tighten their wallets as money loses its value, decreasing economic growth and leading to recession.

When everyone tries to raise prices at the same time, the value of each currency falls sharply. This can cause a recession. In extreme cases, currencies have become worthless.

To maintain price stability, the Bank of Canada (BoC) has an inflation target of 2% per year by adjusting the overnight interest rate. Raising the interest rate increases borrowing costs between banks over one night, making it more expensive for them to borrow money from each other. To keep their costs low, banks increase their own rates.

An increase in interest rates makes people less likely to borrow money, so they rein in their spending and become more likely to save. This puts downward pressure on prices and slows the rate of inflation.

What Is the Relationship Between Inflation and Mortgage Rates?

Rate of inflation affects mortgage rates. When prices of goods increase along with inflation rates, consumers’ purchasing power weakens.

To maintain a profit when lending money, mortgage lenders typically must keep interest rates at a certain level. They watch the inflation rate and adjust their mortgage rates accordingly.

Variable mortgage rates are directly affected by interest rate hikes because they are calculated as a percentage of the prime rate.

Fixed-rate mortgages are not directly affected by interest rate hikes. As rates go up or down, existing fixed-rate mortgages remain at their existing rate.

What Are the Implications of Inflation and Rising Interest Rates for Your Mortgage?

If you have a variable-rate mortgage, your monthly payments have likely gone up to cover the higher cost of borrowing. As interest rates continue to rise, so will your mortgage payment.

As interest rates have risen throughout 2022, many homeowners with variable-rate mortgages are now paying more each month than they would if they had chosen a fixed-rate mortgage.

If you have a fixed-rate mortgage, your monthly payments will not change until your mortgage comes up for renewal. However, when that time comes, your monthly payments will likely be more than they are now.

Should You Switch to A Fixed Mortgage?

If you’re thinking of switching to a fixed-rate mortgage, it’s important to consider where rates are right now and where they’re expected to be soon.

Switching to a fixed-rate mortgage will offer you stability. Your rate and payment will not be subject to fluctuations, so you can rest assured that they won’t change–for the duration of your mortgage.

While a fixed-rate mortgage may seem like the most cost-effective option, it’s important to consider that if interest rates decrease during your mortgage term, you would not benefit from the new lower rates as you would with a variable-rate mortgage. Variable-rate mortgages are currently higher than fixed-rates, but they may not stay that way.

Fixed-rate mortgage holders have rarely come out ahead of variable-rate mortgage holders. But it could be one of those rare times. But for many people, the biggest incentive to make the switch from a variable-rate mortgage to a fixed-rate mortgage is that more predictable payments are possible.

How Can You Minimize the Impact of Rising Mortgage Rates?

Here are some things you can do to prepare for rising mortgage rates:

• Make Extra Mortgage Payments: Mortgages often allow borrowers to make extra payments toward the principal portion of their mortgages, up to a certain amount (varies by lender). As interest rates increase, you may have more incentive now to make an additional mortgage payment in order to help chip away at your mortgage balance. Plus, this can save you money on the total amount of interest owed over the life of the loan.
• Renew your fixed-rate mortgage early: If you have a fixed-rate mortgage, consider renewing early. If you stay with the same lender, they might permit you to sign a new 5-year term without penalty. While you’re likely to pay a higher rate in the near-term, this strategy could help you avoid a large increase at renewal if rates continue to rise.
• Switch To a Variable-Rate Mortgage: When you renew your mortgage, consider switching to a variable-rate loan. This may save you money if there is a significant gap between the going rates for fixed and variable mortgage rates. As mentioned, variable mortgage rates are typically lower than fixed rates, so there could be savings involved if you make the switch sooner rather than later.
• Call your mortgage broker or lender to discuss available options: If rising inflation and mortgage rates make it difficult for you to keep up with your mortgage payments, contact your lender or broker to discuss your options. They will be willing to work with you to find solutions that help you maintain affordable payments. For example, you may be able to lower your payments by switching to a payment frequency that suits your budget, extending the length of time over which you pay off your mortgage or switching lenders.

Ask the Experts

While the debate over whether to prepay your mortgage will likely continue for years to come, the most important thing to remember is that preparing yourself for the future is never a bad idea. Preparation allows you to take on new challenges and reach new goals, and that’s something everyone can get behind.

If you find yourself in a situation where you need help managing your mortgage payments, contact our Orchid Financing team. We can help find solutions that fit your unique circumstances.

Reach out today to book your free consultation!