With mortgage interest rates higher than they’ve been in more than a decade, you could be in for some sticker shock when it comes time to renew your home loan.
By understanding the mortgage renewal process and preparing in advance to pay a potentially higher interest rate , both you and your mortgage will be set up for an easier transition.
1. Higher interest rates could drive payments up significantly
In an attempt to slow decades-high inflation, the Bank of Canada has increased its overnight rate rapidly in 2022. This has had a direct impact on borrowers, since lenders typically increase their prime rates as the Bank of Canada increases its overnight lending rate.
Since March, the Bank of Canada has increased its interest overnight rate six times, and it currently sits at 3.75%. Another increase is expected before the end of the year, as Canada is still seeing high inflation.
Before these interest rate increases, it was pretty common to find mortgage rates below 2%. Now, both fixed rate and variable rate mortgages are hovering around 6%.
If you had a $500,000 mortgage with a 2% interest rate on a 25-year amortization schedule, your monthly payments would have been about $2,180. At current rates, the same mortgage could now cost closer to $3,200 a month, or an extra $12,240 a year.
That’s not to say that your mortgage payments will swell to the same extent. How much they increase will depend on the interest rate you received when you began your last mortgage term. If you were approved at 4%, for example, the next rate you’re offered might be 2% higher, not 4% like in our example above. That’s still a significant increase.
2. You may hit your trigger rate before you renew
If you have a fixed payment variable-rate mortgage, recent interest rate increases may not have worried you too much, since your payments haven’t increased.
But you have been paying less toward your principal, and more in interest, every time the overnight rate increases. This is potentially problematic.
If interest rates continue to rise, your monthly payments may not even cover the interest you owe. At that point, not only are you not building equity, you’re not even keeping up with your borrowing costs. To prevent this scenario, lenders have a trigger rate built into your mortgage contract.
When the trigger rate is reached, your lender should contact you and present a few options. Generally, there are four things you can do in this scenario.
- Increase your payments: A bigger monthly payment means more money to allocate to the principal. This would increase your trigger rate.
- Make a prepayment: Since prepayments go 100% toward your principal, making a lump sum payment would also increase your trigger rate.
- Switch to a fixed-rate mortgage: Switching to a fixed rate mortgage would protect you from any additional mortgage rate increases, but may change your monthly payment requirements.
Take time to review your mortgage contract, as your trigger rate should be clearly listed in writing. If you’re still hazy on the details, don’t hesitate to contact your lender and ask any questions you might have about both your trigger rate and your overall mortgage options.
3. No re-qualifying unless you change lenders
A few weeks or months before your mortgage term is set to expire, your lender should send you a mortgage renewal statement that outlines your remaining mortgage balance and lays out a new mortgage offer, which will include;
- A new interest rate.
- Payment frequency.
- The term.
- Any charges or fees that apply.
Typically, it’s best to compare your current lender’s renewal offer with those of other mortgage lenders since there may be better deals out there that could save you money. But if you decide to switch lenders, you’ll need to re-qualify as a borrower, which includes passing the mortgage stress test when interest rates are painfully high.
But if you accept the mortgage renewal terms offered by your current lender, you won’t need to worry about re-qualifying. Accepting the renewal offer can be advantageous to people who, for various reasons, are in a difficult financial situation and might not be able to qualify with a new lender.
4. Choosing a shorter term could be beneficial
Whether it’s a fixed or variable-rate mortgage, most Canadians typically choose a 5-year term. But mortgage rates may rise further in 2023, so it could be time to consider a shorter term instead.
With a shorter fixed-rate term of one to three years, you’ll be protected if rates go up. And, because you’ll be locked in for a shorter period, you’ll be in a position to take advantage of lower rates — if the market adjusts in your favour — without breaking your contract.
With variable-rate mortgages, you’re still facing the same rate risks no matter what length your term is. If you opt for a shorter term, you could enjoy a bigger rate discount when you renew, but you might also have to withstand more rate increases before the Bank of Canada begins drawing down the overnight rate.
5. Shopping around is worth it
If you have stable income and decent debt service ratios, there’s no reason to accept your lender’s mortgage renewal offer right away. Your best bet is to shop around and compare it to the mortgage rates available elsewhere. You can always use the information you gather to try and negotiate a better deal with your current lender.
Before you switch lenders, keep in mind that there may be additional charges to factor in such as:
- Setup fees.
- Discharge or transfer fee from your current lender.
- Appraisal fee.
- Removal of collateral charge.
While these fees are common, a new lender might be willing to pay for some or all of them to win your business. It never hurts to ask.