Variable rates and most other terms were unchanged ahead of next week’s pivotal Bank of Canada meeting.The Canadian Press
Welcome to Mortgage Rundown, a quick take on Canada’s home financing landscape from mortgage strategist Robert McLister.
One truism about mortgage rates is that they’re cyclical. When the Bank of Canada is done dishing out pain to borrowers, inflation will subside, the economy will stall, and rates will drift back down. It’s mainly a matter of when.
And that’s the thing. With average core inflation at a record high, no one knows how much higher rates need to climb to drive inflation back to its 2 per cent target.
Meanwhile, the gap between five-year fixed and variable rates has dwindled. It hit a long-term high of 224 basis points back in June, enticing borrowers to variable rates despite coming Bank of Canada hikes. That spread has now plunged to an average of just 77 bps. (One basis point equals 1/100th of a percentage point.)
You're unlikely to qualify for ultralow mortgage rates
So which poison do you pick as a mortgage shopper? Elevated fixed rates or elevated variable rates?
I asked RateHub.ca co-founder James Laird what he tells people. His advice: “Ask yourself, will you be more disappointed if you lock in now, and rates drop and you miss out, or if you float your mortgage and rates move up further than anyone expects?”
His logic is, since no one really knows what the future holds, it’s largely a question of what you can tolerate.
Mr. Laird agrees that some mortgage advisers wrongly recommended variable rates ahead of a rate hike cycle. By contrast, his company doesn’t take a position on rates direction, nor make firm recommendations. Instead, he asks borrowers to assess their pain/pleasure preference.
“Two years ago,” he says, “the question we were asking is, ‘Will you be more upset if variable goes up more aggressively than the BoC predicts or more upset if variable stays low and you lose money in a fixed’?” Most people rolled the dice on variables, and in hindsight forgoing five-year fixed rates such as 1.65 per cent or less wasn’t the best move.
Asking the question
There’s a simple elegance in Mr. Laird’s decision-making process. All of us as borrowers need to ask this same question, regardless of whether history shows that variable mortgages win more often. Variable’s success probability is never 100 per cent, albeit it meaningfully increases the more that the prime rate (on which the variable is based) exceeds its five-year average.
Regardless, one can’t forget the exceptional cases. Variable-rate mortgages hit the mainstream in 1981. But had banks offered them in January, 1978, and had you taken one on the advice of a mortgage expert, you’d be cursing that expert’s name for the next five years. From January, 1978, to August, 1981, the prime rate proceeded to skyrocket from 8.25 per cent to 22.75 per cent (1,450 bps).
This time around, central bankers aren’t going to let that happen. That’s why you hear all the talk from Tiff Macklem, the Bank of Canada Governor, about “front-loading” rate hikes. U.S. Federal Reserve chair Jerome Powell is singing the same tune, talking about “acting with resolve now” and “taking forceful and rapid steps” to tighten monetary policy.
But central bankers would be (or should be, based on their track record) the first to admit that they don’t know how much rate tightening is required.
For that reason, and as much as everyone expects rates to drift back down, remember 1978 when picking a mortgage term. Then ask yourself which matters more, your potential risk or your potential reward.
Leveraged GIC buying
“We’ve entered a new phase where GICs are pretty attractive for the first time in about 15 years,” says Jason Heath, a fee-only financial planner at Objective Financial Partners. And with five-year GIC rates at 5 per cent plus, some wonder whether borrowing against home equity to buy GICs makes sense.
At best, the risk-reward is questionable.
Someone with $150,000 of income in Ontario for example, might earn $5,000 of GIC interest and pay $4,000 of line of credit interest per year on a $100,000 investment, Mr. Heath says. That assumes a 5 per cent, five-year, non-registered GIC and 4 per cent average HELOC borrowing rate over the next five years.
The interest income would be taxable, he says, and the line of credit interest would be tax deductible. The net income inclusion of $1,000 would be subject to 43.41 per cent tax, leaving just about $565.90 a year in net income per $100,000 borrowed.
“Personally I’m more in favour of borrowing to invest in rental real estate,” he says. There, a qualified borrower with a long time horizon can leverage that same $100,000 investment up to five times – buying low in a down market with surging rents.
Pressure on fixed rates
The risk of policy rates needing to rise more than expected drove rates higher in the bond market. As a result, the lowest nationally available five-year fixed rates ticked five bps higher for uninsured mortgages this week, and 10 bps higher for insured.
Variable rates and most other terms were unchanged ahead of next week’s pivotal Bank of Canada meeting. The market thinks we’ll get another 75 bps boost to prime rate. The question is, will tough-talking Mr. Macklem deliver another 100-bps surprise? That would go a long way toward convincing those with high-inflation expectations that they’re wrong, and that the central bank is taking no prisoners when it comes to inflation fighting.
Despite surging rates, “There’s still been higher uptake in variable” than fixed, says Jonathan Bundle, head of mortgages and secured lending at HSBC Canada. He wonders whether that will change once variable rates are above fixed rates, which is a distinct possibility before year-end.
And speaking of HSBC, the bank’s HELOC rate of prime minus 0.15 per cent is scheduled to end Sept. 30. If you need a credit line, you won’t find a lower rate.
Rates shown in table are as of Wednesday from providers that advertise rates online and lend in at least nine provinces. Insured rates apply to those buying with less than a 20 per cent down payment, or those switching a pre-existing insured mortgage to a new lender. Uninsured rates apply to refinances and purchases over $1-million and may include applicable lender rate premiums. For providers whose rates vary by province, their highest rate is shown.
Robert McLister is an interest rate analyst, mortgage strategist and editor of MortgageLogic.news. You can follow him on Twitter at @RobMcLister.
Are you a young Canadian with money on your mind? To set yourself up for success and steer clear of costly mistakes, listen to our award-winning Stress Test podcast.