What does a quarter-point rate move cost? The arithmetic for variable-rate debt

The Bank of Canada announced its latest interest rate decision on Wednesday, Oct. 28. Going into it, its policy rate stood at 2.25%, and in a Reuters poll of 34 economists, 19 expected a quarter-point increase to 2.50%.¹ Whatever the Bank did, the question for most households is the same: what does a move of that size cost me?

The answer is a short piece of arithmetic that you can do yourself. This article walks through it for three common kinds of debt. It doesn’t depend on the Bank’s actual decision, so check the Bank’s website for the result.

The quick math: what 0.25 points costs

A quarter of a percentage point is 0.25% a year. Multiply it by the amount you owe:

• On $100,000 borrowed: 0.25% is $250 a year, or about $21 a month in extra interest.
• On $20,000 (a line of credit, for example): about $50 a year, or roughly $4 a month.
• On $400,000 (a mortgage): $1,000 a year, or about $83 a month.

These are interest-only estimates before any changes to how your lender sets payments. A move of one full point is four times as much. Each lender sets its own prime rate, the rate that variable products are priced from, so the timing and size of any pass-through is up to the lender.

How does it work on a line of credit or HELOC?

On an unsecured line of credit or a home equity line of credit (HELOC), the rate floats with prime. Your minimum payment is often based on interest, so it tends to move when the rate does. The Financial Consumer Agency of Canada (FCAC) notes that rising rates can raise the cost of variable-rate loans and lines of credit.² The practical effect is small per month on a modest balance and larger if the line is at its limit.

What about a variable-rate mortgage?

Here it depends on the type of mortgage. The FCAC describes two structures:²

• Fixed payments. Your payment stays the same, but more of each payment goes to interest and less to principal when rates rise. The FCAC defines the trigger rate as the point where “your mortgage or loan payment only covers interest costs.”² Beyond it, unpaid interest can be added to what you owe.
• Adjustable payments. The payment itself moves with the rate.

For a sense of scale, the FCAC gives this example: a $300,000 variable-rate mortgage on a 25-year amortization would go from $1,745 to $2,009 a month if the rate rose from 5% to 6.5%, which is $264 more a month.² That is a 1.5-point move, six times the size of a quarter-point change.

If your mortgage has fixed payments, ask your lender in writing what your trigger rate is. Lenders can tell you their options, which the FCAC says may include higher payments, extra payments or switching to a fixed rate.

What if I have a fixed-rate mortgage?

Nothing changes until your term ends. At renewal, the rate on offer is set by market conditions then, not by the Bank’s last announcement. Our earlier piece on what to do before a mortgage renewal covers the steps, and our look at the Oct. 28 decision explains the Bank’s approach.

MoneySense reported that Ratehub’s Clay Jarvis estimated a 0.25-point increase would lift the lowest variable mortgage rates to about 3.7%, from 3.43%.³ That is one analyst’s estimate, and rates vary by lender and borrower.

What this means for you

1. List every variable-rate debt and multiply each balance by 0.0025 to see what a quarter-point costs per year.
2. Check whether your payments are fixed or adjustable. For variable mortgages, find your trigger rate.
3. Pay down the highest-rate balances first. A credit card charging more than a line of credit costs more whatever the Bank does.
4. Build in a cushion. The FCAC suggests an emergency fund so higher payments don’t force new borrowing.²
5. If the numbers don’t work, talk to a Licensed Insolvency Trustee early. Options include a consumer proposal and bankruptcy, each with trade-offs for your credit and assets. Harris & Partners explains how line of credit debt can be handled, from variable rates to formal options. Our consumer proposal guide covers one route in detail.