Things aren’t looking good for borrowers this year: Economists predict the Bank of Canada will continue increasing the cost of borrowing to keep inflation in check. This means consumer loans and mortgages are seeing higher interest rates, impacting homeowners and cutting into the profit margins for real estate investors.
Your real estate property is an investment. And, like any investment is impacted by a number of fluctuating factors. It’s important to stay updated on the broader market trends to make the best decision possible for your real estate portfolio. Let’s dive into what these interest rate increases are, and what it means for you and your rental property.
What does the Bank of Canada have to do with my rental property?
The Bank of Canada sets the country’s monetary policy to encourage a healthy and stable financial system. While this mandate includes several responsibilities, its actions are mostly aimed at keeping inflation rates low: 1 to 3 percent as measured by the Consumer Price Index.
The most effective tool the Bank of Canada has for managing inflation rate is setting the overnight rate. The Bank of Canada sets a target level for the overnight rate: The interest rate at which major financial institutions (like the Big Six banks) borrow and lend overnight or one-day funds among themselves. Changes in the target level for the overnight rate impact other interest rates, like consumer loans and mortgages.
The Bank of Canada releases target rate announcements on eight fixed dates each year, revealing whether rates will increase, decrease or remain the same. So far in 2019, it has made two interest rate announcements and has kept its overnight rate target at 1.75 percent, which the Bank set in October 2018. This target rate is on the lower end, thanks to high oil prices.
Economists predict another five increases in 2019 to reach a neutral target range of 2.5 to 3.5 percent.
What does this mean for my bottom line?
Rising interest rates make it difficult for both new homeowners and real estate investors to break into the market. High mortgage rates are especially burdensome for investors: a 20 percent down payment is required for investment properties not occupied by the owner, and can only get an uninsured mortgage which comes with higher rates.
Additionally, property owners who make a down payment of 20 percent or greater have to pass the federal mortgage stress test and prove they can afford a mortgage with a rate of 5.34 percent—a benchmark 2 percent higher than most rates.
If you have a variable rate mortgage, the increased rate hikes could increase your monthly mortgage payment, especially with an estimated five rate increases arriving in 2019. Additionally, payments will be going towards interest rather than towards paying off your principal and increasing your amortization period.
The rate hikes will also hurt property owners with fixed-rate mortgages up for renewal. Anyone who hoped to refinance their property will have to consider the cost of the interest rate versus the increased value of the property.
If you’re looking to buy a property this year, which mortgage type is right for you? Variable rate mortgages are tempting when interest rates are low, but the risk is that rising rates will have you paying more than you could have paid—or more than you can afford. Currently, a five-year fixed rate is within 1 percentage point of a variable rate; the slight discount may not be worth the uncertainty, especially as interest rates are set to rise.
Can I raise rent to absorb the prime rate increase?
Raising rent is an important way to protect your investment, but tenants also have protections to ensure affordable housing. Each province has different rent control regulations.
As of April 2017, landlords in Ontario can only increase rent upon lease renewal to a maximum 1.8 percent in 2019. Rent can only be increased once per year for existing tenants in British Columbia, with a maximum allowable increase of 4.5 percent in 2019.
Take into account that not only will your interest rates rise, but you might also see rising maintenance costs! If you’ll be raising rent at the next lease agreement, provide your tenants written notice at least three months in advance.
Investment properties should be treated like any financial asset: With thoughtful evaluation and an eye to market trends. Pay close attention to the Bank of Canada over the next year to plan how best to manage your investment property as interest rates climb higher.