Welcome to the latest edition of Mortgage Rundown, a quick take on Canada’s home financing landscape from mortgage strategist Robert McLister. Read the previous rundown here.
Every now and then investors realize that they’ve underestimated how high interest rates can go. And when they recognize they’re substantially wrong, rates go vertical, quickly.
That’s what happened in the past 10 days. The market’s new rate outlook means three things:
1. Fixed mortgage rates follow big moves in bond yields – so barring a pullback, most banks should boost their fixed mortgage rates, pronto.
In fact, TD Canada Trust took the lead on Thursday. It was the first of the Big Six banks to backpedal on its September cuts and take fixed rates back up.
2. This new round of fixed-rate hikes will be larger than average, likely at least 20 to 25 basis points or more on average, if moves from lenders that compete with the big banks are a guide. (There are 100 basis points in a percentage point.)
TD, for one, jacked up its five-year fixed rates by 30 bps on Thursday.
3. Being the first high-profile rate increase since March, some borrowers will get spooked and rush to secure a fixed rate, potentially leading to a short-term incremental boost in home-buying demand.
How high can rates fly?
How high can inflation go is the better question, because that’s ultimately what will drive borrowing costs.
If you ask this question to the experts, most will parrot the Bank of Canada’s message that excessive inflation is “transitory.” And it may well be.
Then again, no one really knows, because postpandemic recoveries – with acute supply/demand imbalances – don’t happen every day. About the only thing you can do to get a rough, and I mean really rough, sense of future rates is to look to bond market pricing.
As of Wednesday, traders were pricing in three rate hikes in 2022, two in 2023 and one in 2024. “That path brings the overnight rate to 1.75 per cent in three years’ time, matching the peak rate realized in the 2017/18 hiking cycle,” Ian Pollick, global head of fixed income, currency and commodity research at CIBC Capital Markets, said in a report Wednesday. The market projects the eventual peak in Canada’s overnight rate to be roughly 2.5 per cent.
These projections will all change several times in the next three years, so don’t pin your faith on them. Suffice it to say, however, 150-plus basis points of rate hikes during a recovery would be consistent with most cycles in the past, if not a touch conservative. Of course, there’s no telling how long rates would remain near peak levels before the next downturn.
The takeaway: If you plug these latest projections into a hypothetical borrowing cost simulator, you’ll find a 1.99-per-cent five-year fixed outperforms almost any five-year variable, assuming:
- the aforementioned rate path pans out;
- prime rate levels off at 150 basis points higher in years three through five;
- you hold your mortgage the full five years, avoiding prepayment penalties – which can be harsher for fixed-rate mortgages.
Where is the value at?
As of Wednesday, you can still snatch a five-year fixed for just 1.99 per cent (uninsured) and as low at 1.89 per cent (insured). Check online brokers in select provinces for even lower rates.
Rates shown in the accompanying table are as of Wednesday, from providers that lend in at least nine provinces and advertise rates on their websites. Insured rates apply to those buying with less than a 20 per cent down, or those switching a pre-existing insured mortgage to a new lender.
If you do go shopping for a five-year fixed, heed this worthy – if well-worn – advice. Unless there is virtually no chance you’ll break your mortgage early, or unless you need a home equity line of credit linked to your mortgage, lean toward fair-penalty lenders who don’t crush you if you break the mortgage early.
This and that
- National Bank of Canada reports that “more than half of new mortgages made by banks were at variable rates in July.” Borrowers are taking advantage of the lower payments and 75-to-90-basis-point upfront rate advantage of variables. In terms of maximizing home purchasing power, however, it’s generally a tie. That’s because mainstream lenders “stress test” most borrowers with a 5.25-per-cent rate, regardless of whether they choose variable or fixed.
- “The case of higher inflation is building due to greater supply side constraints,” Bank of America says, adding, “The Fed has become more concerned about persistent price pressures.” That affects Canadians, too. If the bond market thinks the Fed will hike sooner to control inflation, mortgage rates in Canada should also rise sooner.
- One’s “loan-to-value (LTV) ratio is the most economically significant predictor of future financial stress” among mortgage borrowers, according to researchers at the Bank of Canada. LTV is simply your mortgage amount divided by your home value. Folks “more likely to experience financial stress include: those with limited equity – especially those with down payments of 5 per cent [and] those with a combination of at least 20 per cent equity and large loans relative to income.”
Robert McLister is an interest rate analyst, mortgage planner and contributing writer for The Globe and Mail. You can follow him on Twitter at @RobMcLister.
