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Canadian Bank Predicts End to Interest Hikes

Written by Posted On Tuesday, 06 June 2000 00:00

How high will interest rates go? In a recent report entitled, "Curren Analysis," the Chief Economist at one of Canada's leading banks predicted "the lion's share of interest rate increases are behind us now" and "the Bank of Canada has reached the end of its tightening cycle."

According to bank economists, Canada's modest inflation rates, higher interest rates, rising energy prices and reduced stock market gains indicate the end is near for short-term interest rate increases in Canada. However, these experts do forecast a final 25-basis point increase by the US Federal Reserve in June.

Past increases in interest rates are credited with a slowing effect on the Canadian housing market, where sales and new home starts have fallen off. Further, since Canadian (and US) households are carrying record levels of consumer debt, additional increases in interest rates would be expected to have a significant affect on spending and cause a greater slowdown in the economy.

The report goes on to say that, "From a macroeconomic point of view a moderating stock market and relatively high energy prices are a good thing – they lead to a more balanced slowdown and less need for further rate hikes."

Assurances of stable interest rates may give Canadian home buyers and home owners a false sense of security.

While higher energy prices may have a positive effect on interest rates, the threatened 50% increases in fuel bills next winter may have a negative effect on the housing market and consumer spending.

Unless you are buying an R2000 house or another style of home with above average energy-saving features, when you calculate what monthly mortgage payments you can afford, you may be wise to add-in heating costs.

A rise in interest rates of 1/4% or 1/2% may mean a difference of only a few dollars per month in mortgage payments. For instance, on a $100,000 mortgage, with an amortization period of 25 years, an interest rate of 8 1/4% would mean a mortgage payment of $779.23, principal and interest, per month. Increase the rate to 8 ½%, and the monthly payment is $795.37. Raise the rate by ½%, and you would pay $811.62 a month. While these amounts can add up over years of paying a mortgage, they would not be enough to deter a buyer determined to use one or more of the cost-reducing methods, such as bimonthly payments, available to pay off the mortgage more quickly.

On the other hand, the predicted increases in heating costs may mean many hundreds or even thousands of dollars will be added to the cost of running your home and reduce the amount of financing you may qualify for. For instance, lenders will use calculations such as Gross Debt Service Ratio (GDS) to build in fuel increases. A GDS of 30% usually requires that principal, interest and property tax payments do not exceed 30% of your combined gross income. With sky rocketing fuel prices, lenders may alter the calculation to include annual heating costs, leaving less money available for principal and interest payments.

Increased heating expenses for businesses and service providers will also be passed on to consumers.

While experts are busy debating the effect of small increases in interest rates, Canadian home buyers and owners may be impacted more by energy costs, especially if we have a particularly cold winter.

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