Tara Perkins

Toronto — Globe and Mail Update and The Canadian Press Published on Monday, Mar. 29, 2010 9:03AM EDT Last updated on Monday, Mar. 29, 2010 4:45PM EDT

Three of Canada’s largest banks are raising rates on some fixed-rate mortgages, a reminder that mortgage rates can go up before the central bank’s key interest rate does.

The move comes as many Canadians with variable-rate mortgages have been anxiously watching for signs of exactly when the Bank of Canada will begin hiking interest rates, in a bid to wait and lock into a fixed-rate mortgage at what they hope will be the ideal time.

Royal Bank of Canada (RY-T59.45-0.37-0.62%) , the country’s largest bank, said Monday morning that it is raising the rate on three-year closed fixed-rate mortgage by 0.20 percentage points to 4.35 per cent. The four-year closed rate will increase by 0.40 to 5.34 per cent, and the five-year closed rate will rise by 0.60 percentage points to 5.85 per cent.

RBC’s Canadian mortgage portfolio amounted to about $148.5-billion in the latest quarter.

A short time later Toronto-Dominion Bank (TD-T75.57-0.43-0.57%) followed suit, saying it is raising its three-year closed fixed-rate mortgage rate by 0.40 percentage points to 4.70 per cent, its four-year rate by 0.40 percentage points to 5.34 per cent and its five-year rate by 0.60 to 5.85 per cent.

Laurentian Bank (LB-T43.80-0.32-0.73%) also announced it would raise rates.

A spokeswoman for Royal Bank said that fixed-rate mortgages tend to move when bond yields move.

“The rates are tied to our funding costs, which change day to day,” she said. “Our long-term funding cost has gone up significantly since December.”

The biggest increase announced Monday affects five-year mortgages. All three banks are hiking their posted rate by six-tenths of a per cent to 5.85 per cent from 5.25 per cent.

A homeowner taking on a mortgage of $250,000 at the new posted rate of 5.85 per cent over a 25-year amortization period would pay $1,577 per month. Prior to Tuesday’s hike, that mortgage would have cost $1489 a month, or $88 less.

Sal Guatieri, a senior economist at Bank of Montreal, said the driving force behind the change in Canada’s bond market is the notion that the Bank of Canada might need to raise interest rates sooner than previously thought. The market’s expectation is pushing up bond yields.

Mr. Guatieri still believes the central bank is on track to raise rates in July, but he acknowledges that further strong economic reports could cause the bank to move sooner.

Rising rates present a dilemma for many homeowners who face decisions about whether to lock variable rate loans into fixed terms or ride it out and hope that rates will come down again in 2011 as the economy slows and inflationary pressures subside.

Potential homebuyers entering the market also must consider rising rates when they decide to bid on a house. Is it better to wait until rising rates have cleared out some potential bidders or will a flurry of buyers and sellers spooked by the prospect of higher mortgage costs affect the supply-demand balance?

Historically, staying short-term and flexible has been the best strategy, but banks usually advise that locking in at still-attractive longer-term rates of five years and more is always a good bet for many consumers who want to ease their risk.

If the current bank prime rate of 2.25 per cent rises by 2.5 percentage points to 4.75 per cent, a homeowner with a variable mortgage should expect to pay about 30 per cent more on their monthly mortgage, says Robert McLister, a mortgage planner and editor of the Canadian Mortgage Trends website.

“If that causes you discomfort then perhaps a fixed rate’s where you want to be and if a fixed rate is where you want to be…if you’re closing in the next six months, I suggest people do that quickly.”

Generally, long-term fixed rates rise by about half of the variable rate, he said.

While the fixed versus variable decision is specific to each individual, Mr. McLister said if prime rates spike by more than 2.5 percentage point, odds are good homeowners will save money in a five-year fixed rate mortgage.

Potential homebuyers should get their pre-approval applications in fast and expect delays in pre-approvals due to increased application volumes, he said. And homeowners’ with mortgages up for renewal would also be wise to lock in rates as far in advance as possible.

Mr. McLister said its difficult to tell if the bank prime rates will rise by 2.5 points, but he added the banks have embarked on a cycle of rate increases and rates in the near and medium term will continue to rise before falling again.

“They came down in the most recent rate cutting cycle by 4.25 (percentage points), so going up about half of that is definitely achievable,” he said.

Mr. McLister added that most economists expect a half to one point increase in banks’ prime rates by the end of this year.

But using recent history as a guide, its not likely rates will rise much higher than 2.5 per cent.

“When the rates go up three (percentage points) or so they don’t stay there and go in a flat line. They go up and they go down.”

Banks are competing more aggressively for mortgage clients than ever, but Mr. McLister noted that consumers should expect other banks to follow RBC and TD in the days ahead as banks often move rates in unison.

CIBC chief economist Avery Shenfeld said mortgage rates hikes are a trend consumers should expect to continue.

“Once the Bank of Canada starts pushing up short-term interests rates, and even in anticipation of that, it tends to spill out across the rest of the curve.”

He predicts the Bank of Canada will gradually raise key lending rates this summer, resulting in an increase of 0.75 per cent to one per cent by the end of the third quarter.

That would raise the average prime rate at the banks from 2.25 per cent to three per cent, which could tack on three-quarters of a per cent to the rates of homeowners with floating mortgage rates, Shenfeld said.

“Consumers are forewarned that when they look at borrowing today they have to factor in potentially higher costs,” he said.

“Consumers have to be aware in taking on debt at historically low interest rates that down the road they will be higher and have to leave room for their ability to pay those higher rates.”

When the Bank of Canada lifts rates, part of its intention is to take the fire out of the most interest sensitive segments of the economy, including the housing market, which has seen a particularly strong recovery, Mr. Shenfeld said.

The hot housing market is being driven, in part, by an influx of consumers willing to pay a premium for home ownership before interest rates rise.

Mr. Shenfeld said the rate increase could help dampen the house price inflation seen over the past several months.

Gregory Klump, chief economist at the Canadian Real Estate Association, said even though mortgage rates are rising, they are still historically low.

“Even with interest rates expected to rise over the second half of this year, it’s going to be a while before mortgage rates are basically neutral. Even with interest rates rising they’re still going to be stimulative, just not as much.”

“We’re coming off emergency level rates, and clearly the emergency has passed.”