An even bigger rate hike is expected Wednesday — and housing will take another hit, experts say

The Bank of Canada's widely expected interest rate hike on Wednesday will come as bad news for homeowners who may see their mortgage rates climb while the value of their property falls.

Economic data reflects a tumultuous moment for the Canadian economy, with inflation reaching a 39-year high of 7.7 per cent in May and recent surveys from the central bank showing low consumer confidence.

Bay Street analysts broadly anticipate the Bank of Canada will raise its overnight interest rate by 0.75 of a percentage point on Wednesday, bringing its policy rate to 2.25 per cent in an effort to slow the rapid growth of consumer prices.

Those rates may seem low relative to historical standards - the central bank's policy rate typically sat above two per cent until the 2008 financial crisis - but the pace at which rates are now being hiked is the fastest in decades, part of an aggressive campaign to slow consumer demand that some economists fear may tip the country into a recession.

The impact of the bank's tightening campaign can already be seen in the housing market, where prices have tumbled about 13 per cent since February, according to the Canadian Real Estate Association.

The higher the rates, the harder it is to borrow money, meaning prospective homebuyers will find it harder to finance down payments while current homeowners will pay more on their mortgages.

A 75-basis point increase will slow down purchases even more," said Sung Lee, a licensed mortgage agent with rates.ca. We are already seeing people walking away from housing deals. The mindset has shifted."

Homeowners who locked into historically low five-year fixed-rate mortgages in the past half decade are now likely to face higher rates when their mortgages are up for renewal, said Lee.

According to ratehub.ca, a homeowner with a five-year fixed-rate mortgage of 1.99 per cent on a $500,000 home, amortized over 25 years, has a monthly mortgage payment of $2,155. If their mortgage rate increases by two per cent, bringing it to 3.99 per cent, their monthly payments will be roughly $2,528.

When the overnight rate goes up, the effects are felt immediately by some, such as variable rate mortgage and HELOC holders, but will be felt by others much later when they take on a new mortgage or renew," said Lee.

The typical rate of a home-equity line of credit (HELOC), a loan that is secured against the borrower's home and generally comes with lower interest rates, is expected to jump to almost five per cent from roughly 4.2 per cent, said Rob McLister, a mortgage strategist.

We'll see more budget-strapped borrowers making interest-only payments as a result," McLister said.

The housing market is at the heart of Canada's major inflationary pressures, where the typical home price surged by more than 50 per cent while record-low interest rates sparked frenzied consumer demand during the pandemic.

But high inflation, driven largely by energy and food prices, has prompted Bank of Canada governor Tiff Macklem and his team to adopt a tougher stance. Today's inflation rates are well above the bank's target of two per cent, offering a grim reminder of how inflationary pressures spirally upwards in the 1970s and '80s.

Now, the central bank is trying to lower inflation without cratering the economy - a tricky manoeuvre known as a soft-landing" that has little precedent in the history of Canadian monetary policy.

In model scenarios released by the Canada Mortgage and Housing Corporation (CMHC) on Monday, the federal agency said it expects the Canadian housing markets to experience a downturn by mid-2023.

In a moderate interest rate scenario, where rates increase only by another 0.5 per cent, home prices will decline by roughly three per cent by mid-2023 while national housing sales will decline by 29 per cent, the agency said. In a higher interest rate scenario, where the bank's overnight rate rises to 3.5 per cent, home prices decline by five per cent while housing sales decline by 34 per cent.

It's a confusing time for many homeowners and would-be homeowners. What is important to understand is that interest rates are cyclical. At some point in the next few years, we'll see them come back down. In the meantime, they are still on the rise, and we simply need to plan the best we can," said Lee.

Jacob Lorinc is a Toronto-based reporter covering business for the Star. Reach him via email: jlorinc@thestar.ca