*This post was created in collaboration with Alpine Credits
Everything seems to be more expensive these days, including gas, groceries, and housing. Inflation has had a direct impact on these costs, and it affects your mortgage, too.
As inflation increases, so will the cost of your home loan. Let’s take a closer look at how inflation impacts mortgage costs and what you can do to mitigate these expenses.
Key Points
- When the Bank of Canada’s interest rate increases, so do mortgage rates, which means higher monthly payments.
- Variable mortgage rates are immediately affected by the Bank of Canada’s policy rate.
- Inflation rates affect fixed mortgage rates indirectly and are more closely tied to bond yields.
- To hedge against the effects of inflation, consider making extra mortgage payments or renewing early if you can get a lower rate.
- Switching to a variable rate mortgage might also make sense if there’s a big difference between the going rates for variable versus fixed mortgage rates.
How Does Inflation Work?
A low level of inflation is a good thing for the economy and spurs economic growth. But inflation that increases too quickly can do the opposite.
When inflation rises too fast, money loses its value and lowers your purchasing power. As a result, consumers tend to tighten their wallets, as their money can’t take them as far as it used to.
Moreover, when inflation increases quickly, businesses raise the prices of goods to keep up with the inflation rates. When this happens, the value of the dollar can plummet.
If inflation is not dealt with immediately, a recession can ensue. In rare extreme cases, currencies can drop to zero, rendering them totally worthless.
How Is Inflation Affecting Mortgage Rates?
The rate of inflation impacts mortgage rates. The prices of goods increase along with inflation rates, which weakens consumers’ purchasing power.
Mortgage lenders typically must maintain interest rates at a certain level so they can still realize a profit when lending money. As such, lenders keep tabs on the inflation rate and will adjust their mortgage rates accordingly.
Having said that, the level of impact of inflation rates on mortgage rates varies depending on the type of mortgage in question; namely, variable-rate versus fixed-rate mortgages.
Variable Mortgage Rates
Variable mortgage rates are expressed as the prime rate plus or minus the bank’s mortgage rate discount. As such, an increase in the inflation rate has a direct effect on variable mortgage rates because of their relationship to the bank’s prime rate.
For instance, the current prime rate is 5.95%. A variable mortgage rate could be expressed as prime minus 1.4% (or 5.95% – 1.4%), which would work out to 4.55%.
However, if the Bank of Canada increases the overnight rate by 0.25%, the banks may respond by raising their rates by the same amount. In this case, your variable mortgage rate would inch up to 4.8% (5.95% + 0.25% – 1.4%).
Fixed Mortgage Rates
While inflation rates affect fixed mortgage rates, they don’t have a direct impact as they do on variable mortgages. For starters, inflation rate increases or decreases don’t impact those who already have a fixed-rate mortgage. In fact, these individuals won’t be affected unless they’re due for a mortgage renewal.
Similarly, those looking to purchase a property would be affected, as their purchasing power will decrease as fixed rates increase.
However, while fixed-rate mortgage rates may increase when inflation rates rise, they are not directly linked to the prime rate. Fixed mortgage rates are more closely tied to bond yields.
When these yields rise as a result of an increase in inflation rates, fixed mortgage rates respond accordingly. In this way, inflation rates have a more indirect impact on fixed mortgage rates.
How Does Inflation Cause Mortgage Rates To Go Up?
Using the figures from the above example, the following chart provides a visual of how variable mortgage rates can increase due to inflation after the Bank of Canada increases its overnight rate:
| Prime Rate | Rate Discount | Final Mortgage Rate | |
| Original Interest Rate | 6.7% | 1.4% | 5.3% |
| New Rate After Rate Cut | 5.95% | 1.4% | 4.55% |
Even though the mortgage rate discount remains the same, the Bank of Canada’s increase in its overnight rate will cause the mortgage rate to increase in this example.
Will Mortgage Interest Rates Decrease If Inflation Decreases?
When inflation soars, the Bank of Canada may increase its target for the overnight rate. This makes it more expensive to borrow money and encourages consumers to save money. In turn, consumer demand decreases, which can help curb inflation.
In the Bank of Canada’s latest rate announcement, the key interest rate was cut to 3.75%. When that happened, banks responded by reducing their mortgage rates.
Since fixed rates are tied to bond yields, as mentioned, the effect of inflation may be more indirect. Generally speaking, when inflation is rising, bond yields typically follow suit. The opposite is also true: if inflation trends downward, so will bond yields. In turn, fixed mortgage rates will also decrease.
Should You Switch To A Fixed Mortgage?
Your decision to switch to a fixed-rate mortgage comes down to where rates are right now and where they’re expected to be in the near future.
Variable-Rate Mortgage
While variable-rate mortgages have historically been proven to be less expensive over time, you need to be able to handle the interest rate fluctuations.
Fixed-Rate Mortgage
Fixed-rate mortgages are ideal when rates are relatively low, but may soon increase. By locking in a lower rate when you take out a mortgage, you can guarantee that your rate will stay where it is, even if rates start rising afterward.
This offers stability and predictability with your rate and mortgage payments, helping you budget more effectively. During times of rising inflation — which is the case right now — you won’t have to worry about your mortgage rate increasing throughout the duration of your mortgage term.
At the end of the day, more predictable mortgage payments may be the biggest incentive to make the switch to a fixed-rate mortgage.
Tips On Mitigating The Effects Of Inflation On Your Mortgage
While you may not have any control over what mortgage rates are doing right now, there are a few things you can do to hedge against rising inflation and how it impacts your mortgage. Here are a few helpful tips to protect yourself against increasing mortgage rates:
Make Extra Mortgage Payments
Most mortgages allow borrowers to make extra payments toward the principal portion of their mortgages, up to a certain amount (varies by lender). As rates increase, you may have more incentive now to make an additional mortgage payment to help chip away at your mortgage balance. Plus, this can help you save on the total amount of interest you owe over the life of the loan.
Consider An Early Mortgage Renewal
If you have a fixed-rate mortgage, it might be worth it to renew it before the term ends. Some lenders may allow their clients to sign onto a new term without charging any early renewal fees.
It’s possible that the rate you’re charged at the time of renewal may be a bit higher than the rate you originally locked in at. However, renewing early could help you avoid even higher rates if you wait longer to renew.
Switch To A Variable-Rate Mortgage
At the time of renewal, consider swapping your fixed-rate mortgage for a variable-rate home loan. This tactic could help you save money if there is a significant gap between the going rates for variable versus fixed mortgage rates.
As mentioned, variable mortgage rates are typically lower than fixed mortgage rates, so there could be savings involved if you make the switch sooner rather than later.
Where Can I Get The Lowest Mortgage Rate?
Generally speaking, big banks tend to offer lower rates compared to alternative lenders, though this isn’t necessarily always the case.
Borrowers with excellent credit and solid financials will have an easier time getting approved for a mortgage with a traditional bank. They may also be able to secure a lower rate as a result of their positive credit and financial profile.
Alternative lenders are better suited for those who have less-than-perfect credit or non-traditional income sources. These lenders are not federally regulated and therefore have more flexible loan qualifying requirements. However, the trade-off is that these lenders tend to charge higher interest rates as a result of the higher risk.
No matter what type of lender you choose, there are a couple of ways to find the lowest rate on a mortgage:
- Loan comparison sites. A site like Loans Canada will populate a list of lenders, their products, and their associated rates and fees. From this list, you can quickly scan and find the lowest rate on a mortgage based on your credentials.
- Mortgage brokers. Brokers work independently and deal with multiple lenders across Canada. They’ll shop around and negotiate on your behalf to find you the right lender that can offer you the lowest rate based on your income and credit score.
Ultimately, mortgage interest rates are more likely to vary among consumers, and not always lenders. To get the lowest rate, it’s important to apply with a high credit score and strong income. Then, compare mortgages and rates from various loan providers.
Will Canada Go Into A Recession?
To prevent this from happening, the Bank of Canada (BoC) has a target inflation rate of 2% per year. This is done by having a target overnight interest rate, which determines the borrowing costs between banks over one night. Banks increase their rates when the overnight rate rises to keep their costs low.
Simply put, when prices increase, the BoC increases its overnight rate, which drives banks to do the same with their rates. In turn, this diminishes consumer borrowing power, causing them to borrow and spend less. In response, businesses reduce their prices to compete.
Are We Already In A Recession?
Recent data from Statistics Canada showed the economy inched up only 0.2% in February 2024, falling short of analysts’ estimates of 0.4%. This may be an indication that Canada’s economy is not strengthening at a healthy pace.
Further, the Gross Domestic Product (GDP) per capita is down 3% from its September 2022 peak. Experts say that such numbers are only seen during a recession and have therefore suggested that the Canadian economy is already in a recession. On the other hand, others think a recession may be looming.
Such a scenario is prompting industry experts to encourage the Bank of Canada to slash the overnight rate by its next announcement, which they did by 0.25 basis points in June 2024 and another 0.25 basis points in July 2024.
Will Inflation Finally Start To Decrease In Canada This Year?
The rate of inflation in Canada has dropped considerably since its peak of 8.1% in June 2022. Today, the rate of inflation is down to 2.69%. This rate is just under than the long-term average of 3.15%.
As mentioned, the Bank of Canada has cut the policy rate to 3.75%. This has resulted in bank lowering their interest rates. Anyone holding a variable-rate mortgage will feel the effects of these lower rates immediately.
Final Thoughts
Inflation will certainly have an impact on your housing costs, but there are certain strategies and steps you can take to minimize the effects on your wallet. If you’re able to make additional mortgage payments or switch your mortgage to something more affordable, consider doing so. Otherwise, speak with your mortgage lender to find a solution that works best for you.
Mortgage And Inflation FAQs
Why do mortgage rates go up with inflation?
Can my lender help me with my mortgage?
Will higher interest rates cool the housing market?
Note: Loans Canada does not arrange, underwrite or broker mortgages. We are a simple referral service.
