What happens to a $300,000 mortgage if interest rates go up by 1.5 per cent?

It’s scary–and it shouldn’t be

The Bank of Canada announced on Tuesday it’s going to leave the key interest rate at one per cent. No big surprise there. But the Bank was sounding more optimistic than it has been recently on the state of the Canadian economy–hinting that rates may start climbing soon. Now, governor Mark Carney has sounded hawkish before and then held off. As CIBC wrote in a note to clients:

“It’s déjà vu all over again … recall that in mid-2011, Governor Carney’s team was even more convinced that the need to tighten policy was at hand … but an economic bump in the road waylaid those plans, including a [...] drop in Canadian GDP and the subsequent eurozone crisis.”

The Bank may well hit a similar bump again this year, with Europe struggling with gaping budget holes again and the U.S. recovery wobbling. So if you want to shrug it all off and keep wallowing in cheap credit, you can quote the pros.

BUT whenever the Bank does kick off the tightening–and the time will come, eventually–it will have a long way to catch up. A recent report by the Conference Board of Canada estimates that, based on the pace of the Canadian economy (and ignoring factors that are constraining our maneuvering space on monetary policy, such as the situation in Europe and the Fed’s interest rate target), our key interest rate right now should be 2.5 per cent. Imagine that.

What would a $300,000 mortgage look like if interest rates climbed up by one and half percentage points? (For an overview of how the key interest rate affects mortgage rates, click here.)

To figure it out, we use the detailed mortgage payment calculator of RateHub, a website that compares Canadian mortgage rates–these are rough, back-of-the-envelope calculations, of course, but they give us an idea of what these interest rate movements would do to Canadians’ pockets. Here’s what a five-year flexible mortgage at a 2.9 per cent rate (one of the lowest available for that term) looks like right now, with the key interest rate at one per cent:

That is, in five years, you pay just under $40,000 in interest rate and almost $44,000 in principal. That roughly boils down to $1,397 in monthly payments–$689 going toward paying down the principal, and $707 in interest.

Here’s what things would look like if the key interest rate was 2.5 per cent (i.e. our calculations were based on a hypothetical 4.4 mortgage rate):

In that very same five-year time frame, you pay off  less than $37,000 in principal and as much as $61,000 in interest. That translates to $1,635 a month, of which a whopping $1,073 is interest. That’s $366 more a month in interest rate charges. You could almost get yourself a new BlackBerry Bold with that much money (whether you should actually use the cash for a BlackBerry is an entirely different question…).

Sounds scary? Well, that’s what paying for a house used to be like. Worse, in fact. According to the Conference Board the “normal” interest rate (i.e. one that does not stimulate or slow down the economy) is over four per cent. Would your wallet be ready for that?




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What happens to a $300,000 mortgage if interest rates go up by 1.5 per cent?

  1. Sure, but a) mortgage rates don’t just go up automatically when the B of C’s rate goes up, and b) it’s not like Carney’s going to come out in the near future and announce that the B of C is raising interest rates by 1.5% ALL IN ONE SHOT.

    •  I would still probably recommend that anyone who has or is getting a mortgage to lock in their rate now, so they know what their costs will be.

      • Securing your rates has its benefits, but it has costs too.

        A quick check says a 5-year fixed mortgage would run me about 5.44% if I locked in today. Meanwhile my variable rate mortgage is under 3%. I could absorb a 2.5% increase in my mortgage rate without reaching the current fixed rate.

        •  Where are you looking for a mortgage? 5 year mortgages are available at 3.19-3.49 from a variety of sources, I can get client 3.99% for 10 years right now, talk about price of mind!

    • Excellent point about the disconnect between mortage rates and BoC’s overnight lending rate.

      Wasn’t it just six months ago or so that mortages rates decreased even further because of a price war amongst the banks ?

      Healthy competition should keep things from getting too out of hand.

      • Yeah but then the banks turned around and asked Wee Jimmie to help them stop. Very strange moment. Wee Jimmie, to his credit, told them to go stuff it- they created the problem, they fix it. Add on to the fact that the banks can just fluff the 0-5% down crowd’s lending risk onto the government (read: you and me). I believe Wee Jimmie refused to up the CMHC’s 600 B cap. Again, good on him. 

        I must tip my cap to the ol’ Ambulance Chaser. I’ve been awful hard on him in the past but he seems to have made some smart moves here to try and deflate the bubble. 

        • So you think the rates charged by CMHC to insure mortgages are too low? If so, why does GE Capital offer the same rates to the same clients for mortgage insurance? 

    • for fixed-rate mortgages you’re right, but VRM (variable rate mortgage) interest rates move in lockstep with bank prime rates which track pretty tight to the Bank of Canada overnight rate, +2%. 

      Anyone who has gotten a mortgage since 2009 would have done very very well by a VRM, and should be planning accordingly for the future, but it’s no less true that rising rates do bite immediately.   I love my 2.4% VRM; we make payments as if the rate was over 4% to ‘save’ for the day that it will be.

  2. Ahh ok except your numbers are incorrect.

    • Hi Jimkeymortgage,

      How so?

      •  Jim is right.  I’m not sure what you’ve done wrong, but I calculate annual mortgage payments ($300k mortgage, 2.9%, 25 yr am) as $16,848.

        In the second scenario ($300k mortgate, 4.4%, 25 yr am) I get $19,728.

        The difference in the balance owing at the end of 5 years is $6,982, while you’ve made $14,400 in additional payments. 

        In both cases I’m rounding the monthly payment to the nearest dollar, but your numbers are about $100 a year off.

        • Hi nmm66,

          That’s probably because my calculations are based on a $325,000 asking price for the hypothetical home, 10 per cent downpayment and 25 year amortization period. The mortgage works out to $298,350, not exactly $300,000. 

          •  Ah. Gotcha.  Regardless of the actual mortgage amount, I think your article illustrated your point.

      •  I get the same numbers as nmm66. 

  3. One possible wrinkle I’ll throw out there: mortgage lenders are aware that it is likely interest rates will go back up again. Yet they are still lending, and people (who probably have at least some inkling of the possibility) are still taking out mortgages. This suggests a few possibilities:

    1. Lenders and borrowers have already incorporated expectations of an interest hike into their calculations and negotiations of the terms of mortgages
    2. People are responding rationally to a bubble. They are taking on mortgages they can’t afford, in the expectation that rising house prices will increase their equity allowing a future renegotiation (as was the case in the US subprime fiasco)
    3. Banks expect an implicit bailout if people start defaulting on mortgages (eg. via the CMHC)
    4. People are behaving irrationally

    Also just curious… who on the Maclean’s editorial board shorted the housing market (not that I think you guys are wrong)?

    • Personally? I think Ken Whyte is looking to buy a new condo.

      However, Paul did point out that their last doom & gloom article on the housing market got a huge amount of views, so they’re probably just doing what they can to boost ad revenues.

  4. Most people only look at the monthly payment anyway.  So, at the lower end of the spectrum at these current low rates, for every 1% increase in rate, there is a corresponding 9% increase in monthly payments.  A 2% increase translates into an 18% increase in monthly payments.  For the majority of people that only look at the monthly payment, this is a HUGE problem if it ever occurred. And the problem is, that IT WILL.  Carney has been warning now for a long time, trying to ease his his own conscience, perhaps?  Yeah, right.  He really had nothing better to do or say…

    xdisciple.blogspot.com

  5. Where does the Conference Board come up with the figure “the normal rate of interest is 4%”?

    Is this referring to the rate between the CB and chartered banks? An aggregate of various interest rates in the economy? Where is the empirical evidence for this argument that 4% = normal? Where can I observe and test this spectacular claim?

    Considering that some money managers are hoping to use this idea to eviscerate peoples’ balance sheets, Macleans should try and be a little more critical about how it digests the econobabble its fed..

  6. And on the other hand, new CPI figures show that inflation is at 1.9%, lower than the 2% target set by the bank.  The dollar is over-valued according to the OECD who suggests it should be trading at about .76cents of the american dollar,  and the government is cutting back spending which slows down the economy there.  Carney raises interest rates now and we head into a tailspin. Dollar goes up, manufacturing dropped further, hell, even profits from O&G go down since we sell in American dollars but produce in Canadian ones — and that’s without looking to what happens to those who are currently living on the bubble.

    Quite simply, until the American economy is strong enough to support us again, or until we get a competent government in who deals with this problem through legislation on permissable mortgages/debt levels as the banks have been asking for, these rates are going nowhere. What this means is pay down as much of your fixed debt as possible while the rates are low, but take back out as much of that debt as you can afford the monthly payments on and drop it into an easily liquifiable portfolio that’s fairly safe but bringing in slightly more interest than you’re paying. With rates as low as they are, it’s not that difficult to find an adviser with some good products in this range.

    When things eventually do start to get better and rates start to rise, cash-out, repay the debt, and the banks will have paid for the small nest egg in profits you should have left over.

  7. Quit your griping. For many years, around the time I got married (1955) mortgages were “set in stone” at 6%. We survived it.

    • I got a mortgage in 1975 at 10.5% and renewed 5 years later at 13% and survived it. But then again, my house in 1975 only cost $34,000 but then again, the household income was only $15,000/yr.

      • In other words, your house cost only 2x your annual salary.
        That multiple is now in the 8x-10x range. Even with today’s lower interest rate, the proportional share of income going to mortgages is higher now.

  8. All of the discussion here is nothing more than wasted wind.  Fact is, almost nobody even knows how money is created, or the fact that there is no money in circulation in Canada in the first place.  It’s all “fiat paper”, with the exception of the 50′s and 100′s, which are even cheaper than that, as they’re now made with plastic!

    It’s a bad sign, folks, when even paper–which actually DOES GROW ON TREES–is too expensive to be used for even the fake money that people THINK has value!

    Quick explanation of “money”:

    If you have a million in cash and your house burns down, you then have a big pile of worthless ash.  You’ve lost what you THOUGHT had a value of a million bucks!

    If you have a million in the bank and the bank burns down, you have a piece of paper telling you how much you’ve got left…which is the limit insured “per member institution”, or $100,000.00, so you lost $900,000.00

    Of course, if the bank has a hard drive crash or a “glitch” in their network, your “money” could be gone with nothing more than a single keypress.  Electronic transfers take milliseconds…and your million bucks could dissapear in just that little snippet of time, any time someone wth access to a computer decides that YOUR MONEY would be better off in THEIR pocket.

    If you have a million in corporate stock and the company fails, your stock is worthless, and without any value whatsoever.

    If you have a million in gold and your house burns down, you locate the pool your gold melted and flowed to, take it to the mint and have it recast, and you have a million in gold.

    If you have a million in silver and your house burns down, you locate the silver slab, take it to the mint, and you’ve got a million in silver.

    But don’t listen to me…just think for yourself for a minute:  Why don’t they teach anybody ANYTHING about money in school anymore?  It couldn’t possibly be that they’re “hiding something” from us, could it?

    • If the price of gold drops, your million in gold is as worthless as pretty much any other corporate stock. You’d be better off with a million in copper, as that at least has intrinsic value and can be used in creating electrical equipment.

      Yeah, the value of money is in our heads. So what? A contract isn’t worth the paper it’s printed on without the various government agencies, such as courts and the like, to back it up. Same as money. Do you propose we go without contracts as well?

    • Fiat money, Gold Buggery and a conspiracy.  Side order of they don’t teach anything in school anymore.  Order up!

  9. Worth asking: what were the median wage and house prices one, two, and three decades ago? Higher interest is less of a concern when the mortgage amount itself is lower, nor is it a concern when income keeps pace with price increases. If income fails to increase enough to chase prices, then home buyers either borrow more, get less, or possibly even both.

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