Inflation has been stubbornly high in Canada for more than three years. Even after the Bank of Canada’s aggressive rate-hiking cycle in 2022-2023, price growth settled only briefly before energy costs, rent, and food pushed the Consumer Price Index back above the Bank’s 2 % target. 

When inflation rises, interest rates may follow, and that makes every decision about your mortgage more consequential. Let’s have a look at how inflation influences mortgages and what to do during rising times. 

How Inflation Influences Mortgage Rates in Canada

The Bank of Canada is the main player when it comes to tackling inflation. Their usual move? Bump up the key overnight rate. This ripples through the system to the prime rate that banks use as a base for your mortgages. So, when the prime rate increases, those variable-rate and HELOC mortgages get more expensive.

Remember 2022-2024? The Bank of Canada raised rates trying to beat back inflation. Variable-rate mortgage holders felt it hard – their payments jumped, sometimes by hundreds of dollars on a $400,000 mortgage. So, those factors are all interrelated, and you should understand them. Here are the main points of how inflation influences your mortgage:

• Higher borrowing costs: Lenders price mortgages off the Bank of Canada’s overnight rate. Each quarter-point hike flows through to variable-rate mortgages almost immediately.

• Shrinking purchasing power: Rising prices for groceries, gas, and utilities reduce the cash you can allocate to mortgage payments, accelerating “payment shock” when your term renews.
• Stricter qualification rules: Because lenders must “stress-test” borrowers at the greater of 5.25 % or the contract rate + 2 %, higher posted rates mean some buyers get shut out, or must scale back their budget.

Bottom line: Inflation hits both sides of the ledger—what you pay to the bank and what’s left in your wallet for everything else. Proactive planning offsets that squeeze.

Fixed vs. Variable: Making the Right Call in an Inflationary Cycle

• Payment Certainty: Fixed-rate mortgages offer locked-in payments for the entire term, making it easier to budget. Variable-rate mortgages, on the other hand, have payments (or amortization periods) that fluctuate with the lender’s prime rate.
• Interest Costs in an Inflationary Cycle: Fixed rates are usually higher at the start, but may save you money if interest rates continue to rise. Variable rates typically start lower but can surpass fixed rates if the Bank of Canada continues to increase rates.
• Penalty to Break: Fixed-rate mortgages often come with higher penalties if broken early, usually calculated using an interest rate differential. Variable-rate mortgages usually carry a lower penalty, typically just three months’ interest.
• Flexibility: Fixed mortgages are ideal for risk-averse borrowers who prefer stability. Variable mortgages are more suited to borrowers who have a financial buffer and believe rates may drop in the near future.

Tactical Tip: Consider a hybrid or split mortgage, where a portion of the mortgage is fixed and the other is variable. This strategy allows you to balance payment stability with the potential to benefit from lower variable rates.

Strategies for First-Time Buyers During High Inflation

Buying your first place when inflation is high? Yeah, it’s tough, but doable. Here’s how to navigate it:

• Budget like a pro: Don’t just look at today’s rates. Picture them going up. The mortgage stress test is there to make sure you can actually handle it.
• Think shorter term or split: Shorter terms often come with lower rates, and a split mortgage lets you hedge your bets with fixed and variable chunks.
• Widen your search area or downsize: Look a bit further out, or consider a smaller property. It can make a big difference in your mortgage costs.
• Tap into government programs: See what’s out there for first-time buyers – every little bit helps.

Refinancing to Beat Inflation: Is It Worth It?

Refinancing can be a clever move when inflation’s in the air, but do your homework.

• When it might make sense: If you can find a lower rate or roll high-interest debt (credit cards, anyone?) into your mortgage, you might free up some cash.
• Unlock your home equity: Refinancing can give you access to equity to wipe out those high-interest debts.

Caution: Watch out for those penalties for breaking your current mortgage early. Calculate the costs to see if the refinancing benefits outweigh the cost.

Accelerated Repayment: A Hedge Against Rising Costs

Paying extra on your mortgage is essentially a guaranteed after-tax return equal to your interest rate—a compelling proposition when borrowing costs hover around 6 %. Use these tactics:

• Bi-weekly accelerated payments: You’ll make the equivalent of one extra monthly payment per year, shaving four years off a 25-year amortization.
• Annual lump-sum pre-payments: Apply tax refunds, bonuses, or investment proceeds directly to principal. Many lenders allow 10-20 % of the original balance each year without penalty.
• Round up each payment: Even $50 extra per payment chips away thousands in interest over time.

Be sure your emergency fund is healthy first; liquidity cushions you if inflation pushes other living costs higher.

Long-Term Planning: Inflation-Proofing Your Mortgage Strategy

Protecting your mortgage from inflation is a marathon, not a sprint:

• Build up your savings cushion: Having some backup funds can help you weather any unexpected rate hikes.
• Get pre-approved and stress-tested: Make sure you can handle payments if rates go up – it’s a must.
• Talk to the experts: Mortgage brokers can give you custom advice based on your situation and what’s happening in the market.
• Annual mortgage check-up: Even mid-term, review your mortgage every year to make sure it still fits your needs.

Navigating the mortgage maze during inflation calls for careful planning and help from the professionals. Know how inflation impacts mortgages, weigh your rate options, and come up with a solid repayment plan – that’s how you secure your financial future.

And in times like these, an expert is worth their weight in gold. A good mortgage broker can offer personalized guidance, so you can make smart choices that align with your goals.