The Bank of Canada’s recent decision to cut its key interest rate by 25 basis points (bps) has had a major impact on Canadians. Reducing the policy interest rate to 4.75% is the first cut in over four years.
During the COVID pandemic, inflation peaked at 8.1% in the summer of 2022. In May 2024, the core inflation increased slightly to 2.9% (up from 2.7% in April 2024). Find out how the overnight interest cut will affect household debt loads this year.
Immediate relief for variable-rate mortgages
Each time the Bank of Canada reduces its key interest rate, monthly mortgage payments decrease. The interest rate cut provides immediate financial relief for those with variable-rate mortgages. This relieves the financial pressure on households by freeing up disposable income to cover other expenses.
Upcoming renewals for fixed-rate mortgages
Fixed-rate mortgage holders may not see immediate relief from their mortgage payments. However, two scenarios will play out for those who are up for renewal.
The first scenario is that individuals may enjoy a lower interest rate as the market anticipates further rate cuts this year. Renewing at a lower rate can offer major savings for the mortgage term.
The second scenario is that half of homeowners with mortgages will face mortgage renewals this year. These individuals enjoyed low interest rates during the pandemic and may be shocked by a huge payment increase.
Mortgage holders will need to weigh the pros and cons of a fixed and variable mortgage. It will depend on whether they believe the central bank will cut its benchmark rate quickly and substantially. Instead of locking into a lower fixed-interest rate mortgage, they need to decide if it’s worth the risk of a higher variable-rate mortgage today.
Housing market activity
According to a report from Royal Lepage, 56 percent of would-be homebuyers said they put their search on hold during the Bank of Canada’s rate hikes. The recent interest rate cut will make mortgages more affordable. This may encourage some buyers to return to the housing market.
This could increase competition and raise home prices in certain areas. Enough housing supply will be important to keep up with the increased demand. Otherwise, it will make it even more challenging for first-time homebuyers to enter the market.
Managing personal debt
Here’s what Canadians can expect regarding borrowing costs and debt repayment.
Lower Borrowing Costs
The good news is that all the big banks cut their prime rates by 0.25% soon after the Bank of Canada announced the overnight rate cut in early June. This helps Canadians to qualify for a slightly larger mortgage, which has been a big barrier to housing affordability.
Aside from mortgages, the interest rate cut affects other forms of personal debt, such as lines of credit and credit cards. With the interest rates lowering, it reduces the cost of borrowing. This makes it cheaper for individuals to carry and repay debt. In particular, this is beneficial for those with large outstanding balances as it can help lower monthly payments and reduce debt.
Strategic debt repayment
It’s essential for Canadians to plan how they will pay off their various types of debt. One method is to focus on paying down high-interest debt, which can provide significant long-term savings. Another way is to take low-interest debt to pay off high-interest credit cards.
Plus, it’s an opportune time to review household budgets and financial goals. Some people will have lower borrowing costs, freeing up disposable income. So, they may want to allocate this money towards saving, investing or reducing debt. Others may face an increase in mortgage payments when they renew. So, they may need to dial back on their spending in anticipation of this mortgage renewal.
Managing debt requires thoughtful planning and discipline. It may be helpful for individuals to seek advice from debt counsellors to help create a realistic debt management plan.
Relying on credit to bridge mortgage payments
The rising cost of living and high mortgage rates have led households to depend more on credit cards and lines of credit to manage their finances. Some people have turned towards using credit to bridge the gap caused by high mortgage payments. Although this can provide short-term relief, it also increases the overall debt load and financial risk.
In Q1 2024, according to Statistics Canada, the debt-to-income ratio was 176.4%. This means for every dollar of income, a household owes $1.76. “We’re still in a backdrop where households are pretty squeezed,” said Carrie Freestone, a Royal Bank of Canada economist, who believes that the household debt-service ratio has not yet peaked.
As a result, personal insolvencies are rising in Canada. We’re witnessing households without a mortgage (such as renters and mortgage-free homeowners) have overdue credit card payments and auto loans that are surpassing the pre-pandemic levels.
Possibility of further rate cuts
The Bank of Canada is considering further rate cuts in July and August. This will be welcome news for homeowners and borrowers who want to lower borrowing costs.
Douglas Porter, chief economist at Bank of Montreal, said in a note to clients, “This is indeed likely to be the first of a series of cuts, although that series is not going to be a straight line down by any means.”
The odds of a monetary policy rate cut at the next Bank of Canada meeting on July 24 is under 50%, according to Reuters. The markets are anticipating two more rate cuts by the end of the year.
Canadian economy experiencing a soft landing
Fortunately, Canada has avoided a recession with the help of the Bank of Canada. However, the recent interest rate provides a mix of opportunities and obstacles for Canadians. The real estate market may see a slow and steady increase in activity, but market risks and affordability remain a challenge for future homebuyers.
Variable-rate mortgage holders can see immediate relief, while those who carry a fixed-rate mortgage may see potential savings upon their mortgage renewal. Hopefully, Canadians can look forward to gradual rate cuts in the coming year. With careful planning, individuals can manage their debt more effectively as the borrowing costs will gradually decrease.
If you’re trying to manage your debt, you can speak with expert credit counsellors. They can help you create a debt relief plan.
