Five things to know about the Bank of Canada’s interest rate hike

The Bank of Canada raised its benchmark interest rate for the first time in seven years on Wednesday, moving it 25 basis points from 0.5 per cent to 0.75 per cent. The country’s five largest banks all followed, hiking their prime rates from 2.7 per cent to 2.95 per cent, which will increase the cost of borrowing when it comes to everything from variable rate mortgages to lines of credit and other loans.

Here are five things to consider:

IN THEORY

According to Ratehub.com, around 66 per cent of all mortgages held by Canadians has a five-year fixed term, meaning borrowers commit to a rate, lender and certain conditions set out in that time period.

The rest are variable rate mortgages, which usually have lower rates than fixed ones, but fluctuate with the prime, which is now moving up.

Some prudent homeowners have been preparing for this rate hike, often by paying more than they need each month to create a financial cushion for themselves.

IN THE MOST EXPENSIVE REAL ESTATE MARKET

But others — especially those who have had to stretch their budgets and massage the interest rate math in order to get into Canada’s most expensive real estate market — will feel the pinch.

Some are carrying significant mortgages, sometimes with as little as five or 10 percent down payment. The telling thing is the loan-to-income ratio. With average home prices in Vancouver has increased by some 40 percent last year, and incomes staying flat, there are more mortgages with higher, riskier ratios, even though there are new lending requirements that have dampened demand for those type of mortgages.

Some borrowers who already have little wiggle room left to cover costs outside of housing will struggle to keep up when rates increase the cost of their monthly mortgage payments.

ATM MACHINE 

Soaring home prices have made homeowners feel wealthier and they have been borrowing against the hefty paper values of their homes for everything from vacations to renovations. The cost of using their homes like an ATM machine through lines of credit will also go up with the prime rate increase, and this could chill some discretionary spending.

ON THE POSITIVE SIDE

In what’s seen as a sign of the economy’s health, the Canadian dollar moved to near 79 cents the US after the rate hike, closing above 78 cents US for the first time since August 2016.

CREDIT COUNSELLORS SAY

This quarter point rate hike may not make a big difference to many people right now, but the message it sends should. It’s the beginning of what could be several more increases in the next year.

“As much as possible, people should pay down debt. We all have debt, whether it’s $500 on a credit card or thousands on a line of credit. Develop a plan that isn’t about making the minimum payment, but get it paid off, whether it’s a plan for four or five years or ten years,” says Gary Tymoschuk, New Westminster-based vice-president of the Credit Counselling Society.

“If you are already going from paycheque to paycheque, with nothing to spare, and then you have to take your car to the shop and spend $500 and it throws your financial situation out of whack, then you will feel this (rate) hike and need to tweak your spending.”

KEY POINTS

— The Bank of Canada said recent data has increased its “confidence” the economy will continue to grow above potential, meaning excess capacity is being absorbed. The central bank estimates the economy will return to full capacity by the end of 2017. In April, it had predicted the closing of the output gap in the first half of 2018. The bank estimates the degree of excess capacity in the second quarter of this year is between zero and 1 per cent of GDP
— The central bank downplayed recent weakness in inflation, judging the sluggishness as “mostly temporary.” It predicted inflation will return “close to” its target of 2 per cent by the middle of 2018 — which is later than it had predicted in
April. It gave a nod to the sluggishness by saying the overnight rate will be guided by its inflation outlook
— There was no reference to the 2015 rate cuts. One of the big questions investors had ahead of the rate decision was whether the central bank’s focus was the 50 basis points of cuts implemented in 2015. Just last month, Governor Stephen Poloz said that what the recovery “suggests to us is that the interest rate cuts that we put in place in 2015 have largely done their work.” The statement did say the adjustment to lower oil prices is largely complete

BIG PICTURE

Canada is in the midst of one of its strongest growth spurts since the 2008-2009 recession, with the expansion accelerating to an above-3 per cent pace over the past four quarters. That’s the fastest among Group of Seven countries and double what the central bank considers Canada’s capacity to grow without fueling inflation.