Interest rate activity, a deeper look.

Interest rate activity, a deeper look.

Fixed interest rates are on the move, no doubt about it.

There are many predictions about whether or not this is a small fluctuation in the market, or the beginning of a long term trend.

Personally I always liked the phrase ‘Follow the evidence’.  Mind you when the evidence is tea leaves and sentiment, truth become less simple to divine.

Short Story;

  • Longer term fixed rates are moving, not Variable rates.  (still available today – 2yr fixed 2.69%, 3yr fixed 2.94%, Variable @ Prime -.40% – net rate of 2.60%)
  • Are we headed to 5% rates next month, next week?  unlikely in the extreme. Stay calm.  Much of what is happening is based on speculation, the winds of change could easily calm or blow the opposite direction in coming months.
  • Will this rate hike tank the Real Estate market?  unlikely in the extreme.  The net effect is an approximate 7% reduction in borrowing power by clients with less than a 20% down payment. (closer to a 4% reduction for those with 20% or more down)  This will have a negligible effect on overall demand which currently remains strong.
  • Rates remain extremely low, historically speaking.

Long Story;

#1) Which interest rates are moving?

Fixed rates are moving, not Variable Rate mortgages.  Lets start with a quick refresher on the key difference between Fixed Interest rates and Variable Interest rates.

Longer term fixed rates, i.e. the venerable 5 yr fixed, are driven by the Bond Market.  The Bond market is to some degree a reflection of what is happening within the Canadian Economy.  A barometer of sorts.  Arguably at this time a bit of a hyperactive and not so finely tuned barometer.  Will bonds settle down in the coming weeks?  Will fixed interest rates settle down a bit as well?  No sure way to say, although the evidence would point to ‘yes’.

Variable rate mortgages are driven by Prime which is set by the Bank of Canada.  The Bank of Canada meets 8 times per year to adjust the money supply which in turns drives the Prime lending rate up or down, typically in 0.25% increments if at all.  Currently there is little pressure on the BoC to increase prime, some might suggest zero pressure.  As such those in a variable rate mortgage are likely to enjoy their current rate for some time to come.  (there has been no change to Prime, currently at 3%, since Sept, 2010)

Deciding to jump from a variable mortgage to a fixed rate and ‘Locking in’ is a major shift from one set of risk factors to another and is not a decision to be made with haste or without full consideration of all the ramifications.  In particular consideration of prepayment penalties. Speak with (or email) your Broker prior to making any rash decisions.

Locking in today would be akin to jumping from a stable (idling) cruise ship with a fully stocked open bar and buffet to…well to another cruise ship that is docked (after all once you lock in there is no more movement) – however this (fixed) one is currently far more expensive as it is an all cash bar and meals are a la carte.

Am I personally going to jump from my current discounted variable at Prime -.75% (net 2.25%) to a 3% or higher fixed rate?  No I am not.  I see Prime as being stable, and thus my variable rate is not so variable at all.  (I slept soundly last night).

#2)  Is this the beginning of the end? (of sub 3% fixed interest rates)

To some extent I suspect it is, there was a lot of pressure from the Government this past Spring applied to lenders to keep rates above 3%.  No doubt Jim Flaherty is sleeping better tonight.

To be clear though, it seems likely that rates will fluctuate within a .50% bandwidth for some time to come, with some downs along with the ups.

Much of what is happening with CDN fixed interes rates, directed by the Bond Market, is based upon speculation around what the US Fed will do, and also on whether Ben Bernanke’s replacement will be more ‘hawkish’.

Increases based on such speculations can easily turn to decreases in short order.  The coming days will tell, yet further significant hikes in rates based on the current data seem less likely.

#3)  The actual ramifications of the current hike from 2.89% to 3.59% on the Real Estate Market.  Real numbers.

Existing mortgage holders please review this link and/or this link for some mathematics on the true impact of rising rates.  There will not be blood in the streets today, tomorrow, nor next year.  Not due to higher interest rates anyways, and not my own clients either.

What about new buyers looking to enter the market? (along with hopeful sellers)

The recent rate hikes have effectively reduced the amount of mortgage money that a new home buyer qualifies for by about 7%.  Does that translate into a drop of 7% in home prices?  Highly unlikely.

Although this will push buyers on the margins into lower priced product still, if not out of the market altogether, for the most part Canadians tend to borrow less than they actually qualify for.  This has held true for about 80% of my own clients even with extremely stringent qualifying standards in place.  Therefore the overall impact will be small if there is any at all.

However if rates continue upward another .50% or beyond I sincerely hope that somebody in the Federal Government has their finger poised over the ‘undo’ button on some of the restrictions implemented over the past 4 years.  In particular consideration of lengthening amortizations back out in order to keep the majority of buyers in the market.

It can be argued that restrictions have already had too large an impact on first time buyers of entry level properties, much to the benefit of property investors.

The lending restrictions introduced by the Fed and the OFSI were largely in lieu of interest rates hikes designed to create a simulated stability in the housing market, now the reverse may need to be done.  The optics of loosening guidelines will take more fortitude.  Lets hope the Government can maintain a balance of ‘what is good for us’ by ensuring future rate hikes are balanced with a relaxing of the rules that were in effect simulated rate hikes.

interesting times ahead, as always.

Thank you

Dustan Woodhouse



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