- Dave The Mortgage Broker - https://www.integratedmortgageplanners.com/blog -

Canadian Mortgage Rates Are Rising – Should Variable-Rate Borrowers Lock In?

canada mortgage ratesLast week Bank of Canada (BoC) Governor Poloz eliminated any doubt about the BoC’s near-term plans. During an interview on CNBC he said that the two 0.25% overnight-rate cuts that the Bank made in 2015 in response to the oil-price shock have “done their job” and he expressed confidence that our economy’s “surprisingly” strong first-quarter growth rebound would continue.

The market’s reaction was swift.

The futures market raised the odds of a BoC rate rise at its July meeting to better than 50% and the Loonie soared against the Greenback, reaching a nine-month high. Government of Canada (GoC) bond yields surged higher and mortgage lenders wasted no time, quickly raising their fixed rates, which are priced on GoC bond yields, in response.

This marks a rare moment for many of our variable-rate borrowers because the BoC hasn’t raised its overnight rate in more than seven years, which means there are many among this group who have never experienced a rate rise (this is the part where the older generations shake their heads).

Suddenly these borrowers have just been told by the BoC that their rates are going to go up and at the same time, they are nervously eyeing fixed mortgage rates, otherwise known as their conversion parachutes, moving higher.

In today’s post, I’ll explain why the BoC is planning to raise its overnight rate soon, offer my take on the impacts that this will have on our economy, and most urgently, offer my two cents on whether variable-rate borrowers should now convert to a fixed-rate mortgage.

The Canadian economy has performed much better of late. Our GDP rose by 3.7% on an annualized basis in the first quarter of this year (which led the G7 economies), our job growth has consistently exceeded consensus forecasts, and even our beleaguered export-manufacturing sector is showing signs of life.

That last point is key for the BoC because it has long said that any healthy economic recovery scenarios must be export led and underpinned by a strong and stable rise in business investment in our manufacturing sector. The health of this sector is vital because manufacturing jobs have a multiplier effect that stimulates job creation across our broader economy.

This newfound economic strength adds another worry to the Bank’s list because if our current economic momentum marks the beginning of a sustainable recovery, it must now try to stay in front of inflationary pressures. BoC Deputy Governor Carolyn Wilkens recently alluded to this when she said that “If you saw a stop light ahead, you would begin letting up on the gas to slow down smoothly … You don’t want to have to slam on the brakes at the last second. Monetary policy must also anticipate the road ahead.”

The BoC has lots of other reasons for wanting to begin raising its overnight rate. Our extended period of ultra-low interest rates has created potentially destabilizing risks that include:

If the BoC wants to make the case for raising rates in the here and now, the two emergency rate cuts that it made in response to the oil-price shock in 2015 are a good place to start. The Bank believes that our economy has now largely adjusted to lower oil prices, so if that economic emergency has been dealt with, why not remove the emergency rate cuts that accompanied it?

If the answer seems simple, it’s not.

When the BoC pulls its interest-rate lever it creates impacts that are far-reaching across our economy, and that cuts both ways. Here are some examples of the negative impacts that will accompany the BoC’s coming rate rise:

The BoC might argue that now is the time to raise rates because the U.S. Federal Reserve has already raised its policy rate three times and is planning to raise it again in the near future (and the Bank of England and the European Central bank are suddenly sounding more hawkish as well).

For my part, I think the Fed is over-tightening based on current U.S. economic momentum and that its actions may well lead to a U.S. recession sometime within the next twelve months (for reasons that are beyond the scope of this post). While that view might be controversial, consider that past Fed tightening cycles have triggered a U.S. recession about 80% of the time (according to research done by economist David Rosenberg).

If the U.S. economy enters a recession, the Fed will likely cut its policy rate back, and if that happens, the BoC would be expected to follow. But even if I’m wrong and the U.S. avoids recession, I don’t believe that history will mark this as the definitive moment when variable-rate borrowers should have locked in.

Here are five reasons why I hold this view:

Our history says that variable-rate borrowers who convert tend to pay more over time than if they had stayed the course. While past is not necessarily prologue, in his famous fifty-year study that compared fixed and variable mortgage rates, Dr. Moshe Milevsky found that variable-rate borrowers who convert mid-term typically paid more than variable-rate borrowers who stuck it out. In other words, converting your variable rate today will give you peace of mind, but history says that you will probably be locking in additional cost over the long run.

Five-year GoC bond yields surged higher by twenty-eight basis points last week, closing at 1.40% on Friday. Five-year fixed-rate mortgages are still available at rates as low as 2.34% for high-ratio buyers (but not for much longer), and at rates as low as 2.59% for low-ratio buyers, depending on the size of their down payment and the purchase price of the property. Meanwhile, borrowers who are looking to refinance should be able to find five-year fixed rates in the 2.79% to 2.89% range.

Five-year variable-rate mortgages are largely unchanged so far and are still available at rates as low as prime minus 0.80% (1.90% today) for high-ratio buyers, and at rates as low as prime minus 0.50% (2.20% today) for low-ratio buyers, again depending on the size of their down payment and the purchase price of the property. Borrowers who are looking to refinance should be able to find five-year variable rates around the prime minus 0.40% to 0.45% range, which works out to between 2.20% and 2.25% using today’s prime rate of 2.70%.

The Bottom Line: If you’re a fixed-rate borrower, the worst of the rate hikes is likely behind you for the time being because lenders have already adjusted their pricing in response to rapidly rising GoC bond yields. If you’re a variable-rate borrower, my view is that staying the course instead of converting, at least for now, will still prove the better option. While your variable rate may be headed higher soon, for the reasons outlined above, I don’t think the rise will be dramatic, as many now suddenly fear.

David Larock is an independent full-time mortgage broker and industry insider who helps Canadians from coast to coast. If you are purchasing, refinancing or renewing your mortgage, contact Dave or apply for a Mortgage Check-up to obtain the best available rates and terms.