What Happens to Variable Rate Mortgage & HELOC Payments When Interest Rates Go Up?
By Julie Jaggernath
It’s no secret that interest rates have been on the rise. When this happens, the consumer credit products most affected are home equity lines of credit (HELOCs) and variable rate mortgages. So with the high cost of living, it only makes sense that countless Canadians are worried about how they’ll make their payments as rates keep going up. But first, some insight into why the ever-increasing cost of living isn’t the only factor tightening up Canadians’ household budgets.
To help Canadians manage through the pandemic, a series of interest rate decreases occurred in March 2020. HELOC interest rates hit rock bottom and those with a variable rate mortgage had the option to significantly decrease those payments as well. This unfortunately only served to reinforce a reliance on credit to make ends meet. And many hardly realized the trap they were falling into. By the time they did, it was hard to change course.
The Effect of Interest Rate Increases On a HELOC Payment
Consider this example of how an interest only payment on a HELOC balance of $150,000 went up in the first half of 2022. In less than 2 months, Prime jumped up close to what it was at in 2018. While payments based on those rates may have seemed reasonable back then, for many Canadian, the reliance on credit during the pandemic and today’s high cost of living make these same interest rates feel worse than they did 4 years ago.
| Date (2022) | BoC Overnight Rate | Prime Rate | Borrowing Rate P+1% | Monthly Payment |
|---|---|---|---|---|
| April 13 | 0.50% | 2.70% | 3.70% | $463 |
| April 14 | 1.00% | 3.20% | 4.20% | $525 |
| June 1 | 1.50% | 3.70% | 4.70% | $588 |
An increase of $125 each month means either changing your spending habits or increasing your reliance on credit cards to supplement your lifestyle because rate increases are expected to continue through the second half of 2022 and into 2023 due to record high inflation.
How to Prepare for Higher HELOC & Variable Rate Mortgage Payments
The Effect of Interest Rate Hikes on Variable Rate Mortgages
When it comes to variable rate mortgages, while payments are based on Prime, e.g. Prime minus 0.55% for example, actual payments are set at a higher rate and often closer to the qualifying rate. This protects borrowers from frequent changes to their payment amount.
When the interest rate for a variable rate mortgage changes, the portion of your payment that goes towards the principal decreases and the portion allocated for interest increases. HELOC payments are typically set at “interest only” and paying down the principal amount is up to you.
Unless your lender has deliberately lowered your variable rate mortgage payment to its lowest possible amount, your actual payment amount does not change with every interest rate announcement from the Bank of Canada. An extremely low payment can get you by during a difficult time, but leaving it set at its lowest point can be stressful. Knowing that your payment could go up at any time is also a budgeting nightmare, making it that much harder to make ends meet when you’re trying to manage through a dire situation.
Payment Examples for a Variable Rate Mortgage
Consider this example for a $550,000 mortgage. A buyer would qualify for the variable rate mortgage at a monthly payment of $3,293. After the mortgage is funded, to create some breathing room in their budget and depending on their situation, this borrower’s payment could be lowered to $2,688. However, as soon as Prime goes up at all, their payment would increase accordingly.
| Type of Mortgage | Interest Rate | Monthly Payment |
|---|---|---|
| Variable Rate Closed when Prime rate is 3.70% | 3.3% (P - 0.55%) | $2,688 |
| Variable Rate Closed if Prime increases by 1.5% to 5.20% (est.) | 4.65% (P - 0.55%) | $3,090 |
| Alternate Stress-Test Rate (Negotiated rate of 3.3% + 2%)* | 5.3% (3.3% + 2%) | $3,293 |
| Stress-Test (Qualifying) Rate (as of June 2021) | 5.25% | $3,278 |
| Posted 5-Year Fixed Rate (for reference) | 4.85% | $3,152 |
Assumptions: 25-year amortization period, 5-year term, negotiated rate of 1% below posted 5-year rate. For illustrative purposes only. Contact your lender for exact rates and to pre-qualify for a mortgage.
* Understand the stress-test rules and interest rates.
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How Do Changes to Prime Affect Fixed Rate Loans and Mortgages?
Fixed rate loans, mortgages, and credit cards aren’t as directly affected by changes to Prime. However, your ability to keep up with those payments becomes much harder when payments for variable rate mortgages and lines of credit go up. To make matters worse, Equifax Canada reported that credit card spending went up and payments decreased in the last quarter of 2021 compared to the same period the year before. The time to get help turning your situation around is right now, before rates go up more and it becomes that much harder to juggle all of your expenses and bills.
7 Ways to Protect Yourself from Rising Interest Rates in Canada
When Is the Best Time to Get Help With Your Debts?
If you’re exasperated making ends meet, get help to regain control of your financial situation before you start falling behind with payments. While it can feel good to pay off your high-interest credit cards each month with your low-interest line of credit or HELOC, believing that this solved the problem could lead to more spending. Protect yourself from the long-term consequences of leveraging the equity in your home and avoid potentially jeopardizing your dream of home ownership.
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