Anyone who owns a home or has been thinking about buying a home has heard a lot about rising interest rates lately. It's a hotly debated topic, with economists and the media watching the Bank of Canada to see what might happen next.
While most people are aware that interest rates are rising and generally understand what this means for them, many may still not fully understand how these interest rates affect the broader Canadian economy.
The average Canadian has little say in the overall course of the Canadian economy, but that doesn't mean they don't need to understand how it all works. Although it may seem like a dry topic, the decisions of our central banks affect us all on an almost daily basis. And while you can't change their choices, understanding the purpose and impact of their decisions can help you make the best decisions for your financial health.
This article will cover the basics that every homeowner or buyer should know, including how interest rates work, why they rise, and what they mean.
What exactly is "interest" growing?
You'll often hear talk of "interest," but it's rarely explained what kind of interest we're talking about. There are hundreds of different interest rates: mortgages, credit cards, investments and more.
More specifically, the "interest rate" in question is usually the Bank of Canada's (BoC's) benchmark rate, also known as the overnight rate or benchmark rate. This rate in particular has the honor of being called "the rate" because it plays a key role in influencing many, but not all, of the other rates in the Canadian financial system.
Essentially, this rate represents the cost to banks of borrowing money from each other from the central bank, which they do every day to rebalance their holdings. In turn, this cost leads to another key rate, ieBank prime rate.Technically speaking, each bank has its own base interest rate, although they try to harmonize them with each other.
The prime interest rate represents the basic cost of borrowing money for consumers and is determined by adding a premium to the overnight rate. That premium covers all other loan costs that the bank has to bear in order to be able to make a profit.
Banks will use the prime rate to determine the interest rate on many of their loans, especially variable rate mortgages. As you can see, bank rates set by the Bank of Canada can have a big impact on the average Canadian.
Other interest rates are also rising, such as fixed mortgage rates, although these rates are not directly linked to the Bank of Canada's key interest rate. You may also hear about inflation rates, which is a completely different story.
Why is the Bank of Canada raising interest rates?
So far we have found that the Bank of Canada has raised interest rates, which has had a downstream effect on many other interest rates. But why would the Bank of Canada raise interest rates in the first place?
The simple answer can be found in the main mission of the Bank of Canada: to keep inflation low. Their goal is to keep inflation around 1% to 3% per year, as measured by the consumer price index. The Bank of Canada's main concern is keeping inflation at a healthy level to keep the Canadian economy moving. They have several different monetary policy tools at their disposal to accomplish this mission, but the most powerful is their ability to set interest rates.
Since the Bank of Canada is the sole issuer of Canadian paper money, it essentially controls the money flowing into the economy. The simplified concept behind inflation is that prices rise due to an increase in the amount of money in circulation to buy the same goods. By controlling exactly how much money enters circulation, banks can help control inflation.
By increasing the cost of borrowing money from banks, they reduce the aggregate demand for money. When interest rates are high, people tend to spend less and save more, which reduces spending and helps slow the rate of inflation.
The causes of inflation are complex, many of which are international factors beyond the control of the Bank of Canada. But there are also domestic reasons. Factors such as public benefits during the COVID-19 pandemic,Rapid growth in house prices, along with supply chain problems that lead to insufficient supply and higher commodity prices fuel inflation. Some might also point out that falling company prices are the cause of inflation. Although it may be some of these, it is not the only cause of inflation, nor is it the biggest.
Fortunately for us, as far as inflation is concerned, we are doing well together. While we cannot control international factors, central banks around the world are also working to contain inflation in their own countries, which should help the overall global economy.
How far will the interest rate increase go?
No one can say exactly how far the Bank of Canada will go in raising interest rates. Current estimates predict that interest rates will continue to rise at least until the end of the year. Since the central bank has made it clear that it intends to lower inflation, it will basically keep raising interest rates until inflation is under control.
So far, inflation is still rising, despite an increase of more than 1% since the beginning of the year. So yes, you can expect the central bank to raise interest rates again, probably several times this year.
Current forecasts suggest that the Bank of Canada's key rate will be between 2% and 3% by the end of the year. That would be in line with rates in the 2000s, but significantly higher than in the 2010s.
In fact, Canadians are enjoying historically low interest rates despite recent rate hikes. Interest rates have been on a general downward trend since at least the 1980s, when interest rates in Canada peaked above 20%.
The last time inflation was as high as it is now was in 1983, when interest rates were around 10%. While we cannot directly compare the state of the economy in the 80s to today, it is clear that higher interest rates are not unprecedented, in fact our current low interest rates are even rarer in the grand scheme of things.
What does an interest rate increase mean for me?
Although the Bank of Canada manages high levels of monetary policy, the effects of these changes can be felt throughout the Canadian economy.
The biggest and most visible impact on Canadians was the rise in mortgage rates. This is especially true for those who bought a home in recent years and took out a variable rate mortgage that was lower at the time.
Rising interest rates are reflected almost immediately in variable mortgage rates, and those borrowers will now begin to see a significant increase in their monthly payments. The situation is exacerbated by the fact that many new buyers enter the market at a time when prices are particularly high, meaning they pay higher interest rates on higher value loans.
If you have a variable rate mortgage, it may be worth considering refinancing or locking in a fixed rate if you feel the increase in repayments is too much to bear. By knowing what's coming, you can do your best to protect yourself from default.
While Bank of Canada rates do not directly affect fixed mortgage rates, other aspects of its monetary policy, such as quantitative easing, can also put upward pressure on rates.Bond rates that help determine those ratesAs a result, homeowners can see an increase when they renovate.
For those with a fixed rate, rates could rise sooner or later depending on the length of your mortgage, while those who bought before 2020 may not see a huge jump if they renew soon. With any luck, this could mean you have time to prepare for increased home loan costs.
As mortgage rates rise, home buyers won't be able to afford the same high prices, so home values could drop somewhat.While the housing adjustment is far from a direct collapse, which can still mean sellers could end up selling their homes for less than they expected.
Higher interest rates also affect many other types of loans. This can include things like home loans and some credit cards. Generally, this will prevent some borrowing in the near future as debt becomes more difficult to repay.
Businesses must also respond to increased borrowing costs. Not only will their costs increase, but the number of customers they have could also decrease. This will encourage companies to keep prices low. In the long run, this helps reduce inflation and is expected to be seen as a positive even after a few painful years.
But if the economy changes too quickly, spending can become so constrained that companies are forced to lay off workers to cut costs. This period of mass layoffs and economic decline is known as a recession, and it is a real possibility in Canada in the near future.
Ultimately, the Bank of Canada is in a bind when it comes to fighting inflation. This could be accompanied by periods of increased costs for Canadian homeowners, reduced purchasing power, potential job losses and more.
Fortunately, the economy works in cycles, and while rising interest rates may be painful now, they will benefit the Canadian economy in the long run. Unfortunately, we are already at a disadvantage, and while it would be better if we weren't here, there is a way out, even if it takes a while to get there. The best thing Canadians can do now is prepare to protect themselves from financial turmoil, reassess their investment risk tolerance and try to spend and borrow less.
Why will interest rates rise in 2022? ›
In an effort to lessen the size of the Federal Reserve's balance sheet, the Fed also announced that it would be reducing its holdings of Treasury and mortgage-backed securities. In June 2022, the Fed raised the rate by an additional 75 basis points, or 0.75%, in an effort to curb the continued elevation of inflation.Are interest rates going to keep going up 2022? ›
Average 30-Year Fixed Rate
After hitting record-low territory in 2020 and 2021, mortgage rates climbed to a 14-year high in 2022. Many experts and industry authorities believe they will follow a downward trajectory in 2023. Whatever happens, interest rates are still below historical averages.
Real interest rates have rapidly increased recently as monetary policy has tightened in response to higher inflation. Whether this uptick is temporary or partly reflects structural factors is an important question for policymakers.How high will interest rates go in 2023? ›
So far in 2023, the Fed raised rates 0.25 percentage points twice. If they hike rates at the May meeting, it is likely to be another 0.25% jump, meaning interest rates will have increased by 0.75% in 2023, up to 5.25%.How long will interest rates stay high? ›
'I believe by the end of 2023 we will see rates start to fall with a target of between 2.5 to 3 per cent in 2024. 'I believe if the base rate can get back to circa 2.5 per cent, then we will see rates hovering around that mark with a return to products that have not been seen in the mortgage industry for some time. 'Will interest rate go down in 2023? ›
The Mortgage Bankers Association predicts rates will fall to 5.5 percent by the end of 2023 as the economy weakens. The group revised its forecast upward a bit — it previously expected rates to fall to 5.3 percent.Why raising interest rates is wrong? ›
When Fed rate hikes make borrowing money more expensive, the cost of doing business rises for public (and private) companies. Over time, higher costs and less business could mean lower revenues and earnings for public firms, potentially impacting their growth rate and their stock values.Why is it bad when interest rates go up? ›
Rising interest rates typically make all debt more expensive, while also creating higher income for savers. Stocks, bonds and real estate may also decrease in value with higher rates. You can take defensive action to help prepare for bad economical times while growing your overall finances.What will the Fed interest rate be at the end of 2023? ›
|FOMC Meeting Date||Rate Change (bps)||Federal Funds Rate|
|May 3, 2023||+25||5.00% to 5.25%|
|March 2, 2023||+25||4.75% to 5.00%|
|Feb 1, 2023||+25||4.50% to 4.75%|
|Dec 14, 2022||+50||4.25% to 4.50%|
|Loan Type||10-Year Treasury Note High Yield||Fixed Interest Rate|
|Direct Subsidized Loans and Direct Unsubsidized Loans for Undergraduate Students||3.448%||5.50%|
|Direct Unsubsidized Loans for Graduate and Professional Students||3.448%||7.05%|
Will interest rates go down in 2023 or 2024? ›
These organizations predict that mortgage rates will decline through the first quarter of 2024. Fannie Mae, Mortgage Bankers Association and National Association of Realtors expect mortgage rates to drop through the first quarter of 2024, by half a percentage point to about nine-tenths of a percentage point.How long until interest rates go back down? ›
With U.S. home prices dropping and mortgage rates projected to dip sometime in 2024, homebuyers might be wondering if they should wait until next year to land a more affordable deal.Will interest rates go down again in 2025? ›
The predictions made by the various analysts and banks provide insight into what the financial markets anticipate for interest rates over the next few years. Based on recent data, Trading Economics predicts a rise to 5% in 2023 before falling back down to 4.25% in 2024 and 3.25% in 2025.What is the interest rate prediction for the US? ›
In the long-term, the United States Fed Funds Rate is projected to trend around 3.75 percent in 2024 and 3.25 percent in 2025, according to our econometric models.How many more times will the Fed raise interest rates in 2022? ›
The Federal Reserve raised the federal funds rate seven times in 2022, with more on the way in 2023.Will interest rates go down in 2023? ›
After home financing costs nearly doubled in 2022, some relief is in sight for potential homebuyers in 2023. The interest rate for a 30-year fixed-rate mortgage in the U.S. is expected to drop to 5.25% by the end of this year, according to a forecast by the financial services website Bankrate.Will auto interest rates go down in 2023? ›
In December of 2022, the Fed indicated that it expects the funds rate to fall to 4.1% by the end of 2024 after reaching the 5.1% mark by the end of 2023. If that holds true and the federal interest rate begins to fall, auto loan rates should start to drop shortly after.What will interest rates be through 2022? ›
2022: Mortgage rates spike
According to Freddie Mac's records, the average 30-year rate jumped from 3.22% in January to a high of 7.08% at the end of October. That's an increase of nearly 400 basis points (4%) in ten months. As the year concluded, the average mortgage rate went from 2.96% in 2021 to 5.34% in 2022.
The Fed raises interest rates again in what could be its final attack on inflation. Federal Reserve Chair Jerome Powell speaks during a news conference at the Federal Reserve in Washington, D.C, on March 22, 2023. The Fed raised interest rates again Wednesday but signalled it may be the last hike for a while.Will the Fed raise rates in May 2023? ›
The Board of Governors of the Federal Reserve System voted unanimously to raise the interest rate paid on reserve balances to 5.15 percent, effective May 4, 2023.
What is the Fed rate prediction for 2023? ›
The central bank is expected to boost its benchmark rate to a range between 5% and 5.25%, reflecting an increase 0.25 percentage points, according to economists polled by financial data company FactSet.Where will mortgage rates be in 5 years? ›
The predictions made by the various analysts and banks provide insight into what the financial markets anticipate for interest rates over the next few years. Based on recent data, Trading Economics predicts a rise to 5% in 2023 before falling back down to 4.25% in 2024 and 3.25% in 2025.Will mortgage rates go down to 3 percent? ›
“Returning to mortgage rates of 3% or 4% is not going to happen, in my view,” says Yun, who points out that historically rates have been higher. The low rates of 2020 and 2021 were “unique” and those that got them were “lucky,” he says.Should I buy a car now or wait until 2023? ›
Americans planning to shop for a new car in 2023 might find slightly better prices than during the past two years, though auto industry analysts say it is likely better to wait until the fall. Since mid-2021, car buyers have been frustrated by rising prices, skimpy selection and long waits for deliveries.Should I buy a car now or wait until 2024? ›
Generally, higher inflation means less buying power for the money you saved today. It also means higher loan rates that you need to finance your purchase. With the high inflation now, it may be wiser to wait until 2024 to buy a car when inflation will likely be lower.Will mortgage rates go down in 2024? ›
Fannie Mae, Mortgage Bankers Association and National Association of Realtors expect mortgage rates to drop through the first quarter of 2024, by half a percentage point to about nine-tenths of a percentage point. Figures are the predicted quarterly average rates for the 30-year fixed-rate mortgage.What is the current federal interest rate? ›
What is the current Fed interest rate? Data source: The Federal Reserve. The current Federal Reserve interest rate, or Federal funds rate, is 5% to 5.25% as of May 3, 2023. On May 3, the Fed raised interest rates by 0.25%, the 10th rate hike since the Fed began raising rates last March.What is the current interest rate? ›
|20-Year Fixed Rate||7.08%||7.11%|
|15-Year Fixed Rate||6.41%||6.44%|
|10-Year Fixed Rate||6.48%||6.51%|