As a result of the pandemic and disruptions to the global supply chain and market economies, Canada is seeing its highest inflation rates in 30 years. As of December 31, 2021, inflation rates in Canada stood at 4.4% for goods and 2.1% for services. Rates are expected to remain high in 2022, with the potential to increase further over the next five years.
With inflation comes increased interest rates, which impact both variable and fixed mortgage rates. Average Canadian home prices have soared recently, with year-over-year increases of 9.4% in 2020 and 17.8% in 2021. Due to these inflationary pressures, fixed-rate mortgages in Canada have also increased significantly, with the 5-year fixed discounted rate climbing more than 1% over that period.
During that same period, the Bank of Canada’s prime rate hasn’t shifted. Although many economists believe rates will change during the second quarter of 2022, the lack of variability in recent months has created a large gap between the 5-year fixed and variable rates. This gap now stands at between 1.50% and 2.00%.
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Impact of Inflation on Mortgage Rates
Inflation causes the Canadian dollar to have less purchasing power in relation to other global currencies. As the Canadian dollar loses value, other items in Canadian dollars, such as real estate, also lose value. This loss in value affects mortgage-backed bonds and mortgage bond yields directly tied to Bank of Canada mortgage rates. As bond prices increase, mortgage interest rates go down; when bond prices decrease, interest rates go up. Therefore, when inflation increases, the Bank of Canada feels the pressure to increase lending interest rates.
A fixed-rate mortgage is set up on a fixed interest rate for a set period, such as five years. Fixed rates are set according to the Bank of Canada’s price for bond yields at the time when the mortgage is acquired. Fixed rates remain stable for the duration of the fixed term. This is an ideal way to have predictable monthly mortgage payments and hedge against inflation because your rates will remain stable despite fluctuations in bond yield prices and overall inflation rat
A variable-rate mortgage is set up according to a variable interest rate that fluctuates over the course of the mortgage term. The Bank of Canada’s prime rates for lenders are used to determine the variable rates on mortgage loans. With variable-rate mortgages, when the prime rate increases, a smaller portion of your monthly payment is applied to the principle. Increased rates due to inflation can cause increased monthly payments on “open-variable” mortgages and larger monthly payments when mortgages are re-signed at the end of their term.
Choosing Your Mortgage Term
Your mortgage term will depend on your personal financial goals and whether you choose a fixed- or variable-rate mortgage. The most common terms for fixed-rate mortgages are 5, 10, 20, 25, and 30 years. If you have a sizeable down payment (such as from the sale of a previous home), it may be in your best interest to choose a short-term loan in order to discharge that debt as quickly as possible. If you are
looking to enter the real estate market but only have a small amount of capital, it may be better for you to spread out your mortgage over 30 years to reduce your overall monthly payments.
Variable-rate mortgages are most often offered as short-term periods of between 1 and 5 years. This short mortgage term allows you to take advantage of lower interest rates and re-sign for new term lengths in alignment with the current and speculated future economies.
Deciding which type of mortgage is best for you is a personal decision—there is no one-size-fits-all solution. Choosing between a fixed- or variable-rate mortgage depends on your comfort level, profile, and short-, medium- and long-term plans. Consulting with a mortgage professional will help guide your strategy for homeownership.