Rate cut is a positive signal for first-time homebuyers

Over the past two years, the Bank of Canada increased its policy rate from 0.25% in March 2022 to 5% by July 2023 — in an effort to quickly curb inflation. This relatively rapid increase in rates led to higher variable mortgage rates, and this led to an eventual rise in bond yields and higher fixed-rate mortgage rates — dramatically impacting mortgage options and housing affordability across Canada.

The recent rate cut is a positive sign for first-time homebuyers, suggesting a potential trend of lowering rates, which would reduce mortgage costs and could improve housing affordability (as lower borrowing costs helps increase the amount of mortgage a borrower can take on). Not only does it help borrowers qualify for larger loans, due to lower interest rates that help reduce monthly payment obligations, but it also helps lower monthly housing costs.

Bottom Line: Although the immediate impact of a 25 basis point cut is minimal, the trend may boost buyer confidence and encourage more people to enter the housing market. That said, lower mortgage rates can stimulate demand for housing, potentially leading to higher home prices.

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Relief for variable rate mortgage holders

Variable rate mortgages can adjust payments based on the prime rate or extend the amortization period without changing monthly payments. As a result, variable-rate mortgage holders will experience one of two situations with this recent BoC rate cut:

  • Option 1: Your monthly mortgage payments will be recalculated and you will end up with a lower monthly mortgage payment.

For instance, let's assume you had a $500,000 mortgage with a variable-rate of 5.25% and a monthly mortgage payment of just under $2,977. Assuming the BoC rate drop prompts an equal reduction in your lender's prime rate, then your new monthly mortgage payment is $2,908 — for a monthly saving of almost $69. Over 25 years, that's a total savings of $20,622.

  • Option 2: If your payments do not adjust with prime, then your monthly mortgage payment will remain the same and more of your payment will go towards paying down the mortgage debt — decreasing the total amount of interest paid and potentially shortening your mortgage amortization (the length of time to pay down the total debt).

Bottom Line: Variable rate mortgage holders could benefit from lower payments or faster principal repayment if their lender follows the BoC rate drop and decreases their prime lending rate.

Financial impact on mortgage renewers

Homeowners renewing fixed-rate mortgages initially taken out when rates were around 2% will face significantly higher rates, despite the recent rate cut. It’s important to budget for these new payments and explore renewal options with tools like a mortgage payment calculator.

Bottom Line: Despite the recent rate reduction, those renewing mortgages should still anticipate renewing their mortgage term at higher rates. This will have an impact on overall financial planning.

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Lower interest rates on loans

Canadians looking to finance large expenses, such as a new car purchase or home renovation, will pay less to borrow, given the recent BoC rate drop.

Products that rely on a lender's prime rate, such as lines of credit and personal or car loans, will cost borrowers less.

Bottom Line: This reduction in the debt servicing costs — how much it costs to borrow money — could prompt more spending using these types of loans.

Borrowers will spend less in debt servicing costs

Those currently repaying loans that rely on prime rate will notice that reduced rates will either lower their monthly payments or help reduce the interest paid and the time it takes to repay the loan. In both cases, this can help ease the financial burden experienced by Canadians due to rapidly rising rates in 2023.

Bottom Line: With less money going towards interest payments, borrowers should have more disposable income — that can be spent, saved or used to repay debt.

Business will benefit

With lower rates, consumers should have more disposable income and this can prompt an increase in spending. If Canadians choose to use this extra cash on spending, it can help stimulate the economy, if they choose to invest it can help support business valuations that can help with overall business growth.

Another aspect of the rate cut is that companies should now have an easier time finding lower cost loans that can help them grow their business — and this contributes to overall economic growth within Canada.

Dangers of a rate cut

The danger of a rate cut is that it could add to inflationary pressures — a situation the Bank of Canada has spent more then 12 months fighting. Increased borrowing and spending can lead to higher demand for goods and services and could potentially driving up prices leading to a rise in core inflation. Over the next few months, the Bank of Canada will be watching how spending and borrowing contributes to inflationary pressures. If there is no real spike, Canadians could see further rate reductions in the latter part of 2024.

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Romana King Senior Editor, Money.ca

Romana King is the Senior Editor at Money.ca. She writes for various publications, and her book -- House Poor No More: 9 Steps That Grow the Value of Your Home and Net Worth -- continues to be an Amazon bestseller. Since its publication in November 2021, this book has won five awards, including the New York CPA Society's Excellence in Financial Journalism (EFJ) Book Award in 2022.

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