How clients 'can get through the next year in one piece'

What the Bank of Canada rate hike means for HELOC and variable-rate mortgages

How clients 'can get through the next year in one piece'

Yesterday, the Bank of Canada concluded its frenetic rate-hiking run for 2022 with a 50-basis-point increase, bringing its benchmark policy rate to 4.25%.

In a statement explaining its seventh consecutive increase, the central bank pointed to persistently high and broad-based inflation, as well as stronger-than-expected GDP growth in the third quarter as the economy operated in excess demand.

“Canada’s labour market remains tight, with unemployment near historic lows,” the BoC said. “While commodity exports have been strong, there is growing evidence that tighter monetary policy is restraining domestic demand.”

Before the announcement, Statistics Canada reported that the economy added 10,100 jobs in November – the third straight month of increases in Canadian employment – while the unemployment rate dipped to 5.1% along with a fall in the labour force participation rate.

With prior forecasts split between 25 basis points and 50 basis points, the announcement yesterday landed on the more aggressive end of expectations, says Jordan Damiani, senior wealth advisor at Meridian Credit Union.

“I think [the November employment numbers] tipped the scales toward a 50-basis-point hike this time,” Damiani says. “It’ll definitely put more pressure on Canadian households in the coming months.”

The upward trajectory of interest rates will tend to weigh on homeowners with a home equity line of credit. As interest costs rise and more of the household budget goes toward those expenses, they’ll have less room for other necessities like gas and groceries – both of which have been primary drivers of inflation this year.

“In my experience, a household might opt for a HELOC if they want flexibility of repayment,” Damiani says. “The big difference between a HELOC and a mortgage is that often with a home equity line of credit, you can choose to pay interest only.”

For years, Canadians had been under a low-interest rate environment; rates were pushed to near-zero during the height of the pandemic crisis, giving households a further incentive to borrow without having to repay large amounts.

“Now the problem is that rates have more than doubled from where they were,” he says. “Even if it’s interest-only, the monthly servicing costs have become pretty significant, especially with a mortgage when you’re obligated to pay down the principal loan amount. I think there’s a lot of households that maybe took their debt loads for granted, and are now unfortunately under more pressure.”

The BoC announcement indicated that it may be near the peak of its interest rate cycle. From Damiani’s point of view, that means it’s likely to either pause or raise by a very incremental amount more, and rates will likely start declining towards the end of next year.

“If you have a fixed-rate mortgage that’s coming due next year, it’s probably best to lock it into a short-term mortgage for maybe a one-year term,” he says.

The central bank’s decision comes following the latest inflation print from Statistics Canada, which found CPI inflation remained at 6.9% in October. In its statement yesterday, the BoC said there are hints of easing price pressures as shown by decelerating core inflation over three-month windows, though inflation is still well above its target, and short-term inflation expectations remain elevated.

“The longer that consumers and businesses expect inflation to be above the target, the greater the risk that elevated inflation becomes entrenched,” the central bank said.

Noting that rate hikes generally take six to 18 months to filter through to the real economy, Damiani encourages Canadians to plan for a period of additional strain on their family budgets. That includes preparing for at least another year of elevated interest costs and ensuring that debt payments don’t put them in a deficit position.

“The Bank of Canada is intentionally trying to slow down the economy, and it’s working as intended. The silver lining is that this restrictive policy really not something that it would want to continue for multiple years, or could continue,” he says. “So it’s really about how you can get through the next year in one piece, and ideally in 2024, things should start trending in the opposite direction and there’ll be less strain on household budgets.”