Rising interest rates and rental properties: what landlords need to know

Inflation and the corresponding rise in interest rates are on nearly every Canadian’s mind right now. Practically everywhere one looks, there’s talk about the far-reaching consequences of these important financial indicators – but how will these seismic shifts affect landlords and real estate investors? Those who own rental properties will certainly feel the impact of Canada’s rising interest rates, in a number of important ways. We’re already seeing rent prices climb higher as landlords adapt to higher mortgage rates, house prices, and other factors – but this is only part of the story. Today, liv.rent will be walking you through exactly what an increase in interest rates means for Canadian landlords, in terms of the overnight rate, mortgage rates, home sale prices, and more.

Note: This post has been updated to address the January 24, 2024 announcement from the Bank of Canada.

What is inflation?

Inflation is a hot topic at the moment, but what does the word actually refer to, and what are its tangible effects? In the most basic terms, inflation refers to the gradual rise in the price of goods and services over time – or more specifically, the decrease in purchasing power of a currency. This is typically seen as an aggregate measure of the general cost of living, which results in a slowdown of economic growth since individuals have less money to spend on non-essential goods.

At present, Canada’s inflation rate stands at 3.40% as of December 2023, compared to 5.92% on January 31st. For context, The Bank of Canada strives to maintain a 2% inflation rate each year as part of its mandate. This sharp increase has led to, and is the result of, a number of factors. For one, gas prices were up as much as 48% at one point in 2022, with grocery bills increasing by 9.7%. In terms of real estate, inflation also has some bearing, leading to generally higher housing prices across the board, although it isn’t the only factor driving Canada’s currently sky-high housing prices.

What do interest rates represent?

The majority of Canadians are already familiar with interest rates in their daily lives, but it’s important to clarify for this article. Broadly speaking, interest rates are the amount that a lender charges a borrower over time, generally expressed as a percentage of the principal loan. On a federal scale, there are two primary interest rates that individuals, and homeowners in particular, should be concerned with: the overnight rate, and the prime rate. The former is set by The Bank of Canada itself, while individual banks determine their own prime rate. Here’s a brief explanation of each:

Overnight rate

The overnight rate is set by a country’s central bank and is an indicator of the rate each individual bank will set, since they’ll need to cover this rate while still earning a profit overall. When The Bank of Canada raises the overnight rate, it becomes more expensive for banks to borrow money and those costs get passed onto borrowers through higher prime rates.

Prime rate

The prime rate represents the base interest rate that a bank will lend money for in order to cover the overnight rate, as well as account for its own operating costs. This does not mean that this rate is the actual rate that customers will be offered since individual clients can receive discounts based on a variety of factors.

How interest rates relate to inflation

Interest rates are fundamentally tied to inflation since the former is one of the main methods used by countries’ central banks to control the economy. Higher interest rates can be seen as encouraging saving while discouraging borrowing and spending, while lower interest rates are more amenable to higher levels of spending. In response to high interest rates, businesses will typically increase the price of their products more slowly, or even lower them to encourage more spending. Similar effects can be seen in the real estate market. As would be expected, high interest rates make qualifying for mortgages harder, thereby lowering demand which gradually causes home prices to fall accordingly.

It makes sense then that during periods of high inflation, central banks would want to raise interest rates in order to lower prices over time. This is essentially what we’re collectively witnessing now – albeit on a larger scale than we’ve seen in recent memory. Still, it’s important to keep in mind that these changes are always temporary as markets tend to stabilize in due time.

Interest rates and rental properties: what landlords need to know

As interest rates rise, Canadian landlords will likely feel the impact in a variety of ways. Rent prices are expected to continue rising as landlords need to charge more in order to break even on their investment, which may actually result in more profits for those who have either paid off their rental properties in full, or have fixed-rate mortgages at a lower rate. Another unexpected consequence of higher federal interest rates is that there will be an increased demand for rentals in many markets, since fewer potential homebuyers will be able to afford the higher stress tests and monthly mortgage payments.

To give landlords a better sense of what these interest rate hikes will mean, let’s look at three areas where many landlords will notice changes: mortgage rates, credit card interest rates, and savings accounts.

Mortgage rates

To properly explain how mortgage rates relate to inflation and rising interest rates, it’s first important to differentiate between fixed-rate and variable-rate mortgages. If you’re a landlord, you’ll likely already be familiar with these two terms and how they differ. Just in case though, let’s quickly look at the differences in each and how each will be affected by recent events.

Fixed-rate mortgages

Fixed-rate mortgages are a type of mortgage that charges a set interest rate throughout the lifetime of the loan. For those who already own property with a fixed-rate mortgage, good news – you won’t be seeing any difference in your mortgage payments, regardless of how much interest rates increase in the coming months. In fact, this is one of the main reasons why homeowners opt for fixed-rate mortgages, since they offer far more certainty during periods of higher inflation.

On the other hand, if you’re looking to purchase a property in the near future, be aware that it becomes much harder to qualify for fixed-rate mortgages in particular when interest rates are high. This is because payments will be higher if you’re mortgaging a new home during these periods, so stress tests (also known as qualification rate) will be more difficult. Currently, The Bank of Canada‘s qualification rate is set at 5.25%, although most homebuyers will secure a rate of 3.25% or above, which means that they’ll be stress-tested at their rate plus 2%.

Variable-rate mortgages

Variable-rate mortgages are where landlords and homeowners are likely to experience higher monthly payments in the coming months and years. Since by definition the interest rate isn’t fixed, variable-rate mortgages are liable to rise during periods of inflation when prime interest rates increase.

Credit card interest rates

For landlords who use credit cards to finance day-to-day expenses for their rental properties, be prepared to see higher monthly bills as federal interest rates continue to rise. Since merchants such as credit card companies will also experience higher interest rates as banks adjust to inflation, this will be passed on to individual customers as well to accommodate the increase.

Savings accounts

It isn’t all bad news, though – one byproduct of higher federal interest rates is a corresponding rise in interest rates for saving accounts. This means that it’s a good time to stash money in savings accounts as banks hike rates, since your money will earn more interest on its own over time. Still, if inflation continues at its current level, this money still won’t go as far over time.

How will rising interest rates affect rental prices?

Rent prices are fundamentally tied to inflation since they reflect a core part of the cost of living. As inflation rises, so too do rent prices. While in the long term, interest rate hikes are intended to tame this inflationary pressure, the opposite will likely happen in the short term.

At present, higher interest rates are being reflected in landlords’ mortgage payments. This means that many landlords who are re-listing their units are forced to increase the price of rent in order to cover these increases and ideally still turn a profit. Landlords with existing tenants will only be able to raise rent by the provincial maximum in provinces such as B.C. and Ontario.

The reasoning behind these higher interest rates for rental properties is that lenders perceive the risk of an investment property to be higher in times of inflation and eventually recession. This risk will be reflected in the price of the morgage, which in turn is reflected in the cost tenants pay to rent the property.

Mortgage rates for rental properties

Those looking to purchase a property right now should know what to expect when it comes to the mortgage rates they’ll see. As interest rates rise, so do mortgages, so be prepared for higher payments.

The precise rate you’ll be paying depends on many factors such as what type of insitution you’re borrowing from, your own finances, where the property’s located, and the type of property you plan on purchasing. With that being said, the lowest rate for a 5-year fixed-rate mortgage is 4.79% according to Wowa.ca, while the lowest rate for a 5-year variable mortgage is 5.85%. This is a sharp increase from pandemic lows of around 3.2%.

Mortgage rates are almost always higher for rental properties too, since lenders prefer the security of owner-occupied residences. It’s always best to work with a knowledgeable mortgage broker to find the best rates for your needs, and don’t be afraid to shop around before making a decision.

What’s next for Canada’s interest rates?

Canada’s economy is showing promising signs that inflation is beginning to slow, and the Bank of Canada’s monetary policy is following suit. As of January 24, the Bank of Canada has announced that they are once again holding the target overnight rate of 5.00%. This 5.00% rate has been in place since July 12, with another announcement planned for March 6, 2024.

Even with interest rates higher than in previous years, this situation certainly isn’t all bad news for landlords. For those who already own a rental property, expect to see higher demand and higher average rent prices as interest rates rise. The decline in new homebuyers, combined with a variety of other factors such as busy renting season, relaxing travel and immigration restrictions and more will likely spur significant growth in the country’s main rental markets. Particularly for those with existing fixed-rate mortgages, your property is likely to earn you more profit than ever in the coming year. Those looking to buy a home, on the other hand, might have trouble breaking into the market with stress tests more difficult than ever.

What will Canadian interest rates be in 2024?

In order to help curb inflation, these increases are likely to continue until inflation is on track. While fears of a recession still loom, recent job numbers are above what was expected. Though the worry remains that a recession could be looming later in the year, there’s reason to be hopeful given that unemployment rates and consumer spending show promising signs of a “soft landing”.

How high will the Bank of Canada raise rates?

Higher interest rates appear to be having their desired effect on inflation, and experts are optimistic about the future of Canada’s interest rates. While this month did see an increase to the target overnight rate, many experts still believe that the Bank of Canada will begin to lower their rates during 2024.

Inflation has been slowing after eight consecutive increases to the target overnight rate, with the severity of the increases gradually lessening over time, and even briefly pausing in March. It remains to be seen what the rest of 2024 has in store, but landlords & homeowners can at least expect a brief respite in the short term so long as inflation continues to subside.

FAQ: Interest rates, mortgage rates and rental property

How liv.rent helps landlords

In times of economic uncertainty, it’s more important than ever for landlords to rent their units quickly and safely in order to avoid vacancies and costly tenant-related issues. Using liv.rent, landlords can rent their unit in as little as 7 days from listing to signing, with digital solutions for every step of the rental process. Finding qualified tenants is a breeze with marketing and rental management features like listing sharing to Craigslist, Kijiji, and Facebook Marketplace, and tenant screening with the Trust Score – powered by Equifax® credit reports. With this all-in-one rental platform, landlords and property managers can fill vacancies faster with verified tenants.

Resources for landlords

Here are some additional resources for landlords and investors looking to better understand the recent rise in interest rates and the resulting effects. For more tips and advice on how to rent out your property safely and quickly, be sure to check out liv.rent’s blog.

• Updated interest rates in Canada
• The Bank of Canada – Inflation in Canada
• Understanding the overnight rate
• Canadian Bankers’ Association – Understanding interest rates

For landlords whose mortgage payments have or will be affected by rising interest rates, it’s important to price your unit correctly in order to keep your rental property profitable. If you’re considering increasing the rent, be aware that each province has a maximum allowable rent increase. For 2024, Ontario has set this limit at 2.5%, while B.C. has outlined a 3.5% maximum rent increase guideline.

Here are some additional resources related to rent prices and increases:

• Landlord Guide: How Much Should I Charge For Rent?
• Ontario – Residential rent increases
• B.C. – Rent Increases

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