Interest Rates; A Reduction…well um, sort of.

In a follow-up to Jan 9th’s Interest Rates: Pundits, Predictions and Sharknado, a post prompted by a steady stream of (misleading) headlines threatening ‘imminent’ rate ‘shocks’, please read on for key points clarifying details about the realities of the Bank of Canada’s decision to cut their overnight lending rate by 0.25%.

Things are not quite as crystal clear as we would like.

Short Version

  • In a move some thought as likely as an actual Sharknado, the Bank of Canada cut their Prime rate by 0.25%.
  • Wednesday’s Bank of Canada decision validated a sentence I have been repeating to hundreds of clients for several years: Economic Bad News—of which there has been no shortage since 2008—is for the variable-rate mortgage client in fact Good News!
  • Chartered banks and credit unions base lending rates on their own internal Prime rate which is neither specifically nor contractually based on that of the Bank of Canada.
  • Your variable-rate mortgage may or may not see a corresponding 0.25% rate reduction. (I do believe the drop to 2.75% will happen)
  • Historically the chartered banks and credit unions have (almost) always followed the Bank of Canada movement. No final decision appears to have been made yet.
  • The qualifying rate remains the same, Canadians do not currently qualify for any larger a mortgage today than they did the day before the Bank of Canada announcement.
  • Be prepared for discounts on NEW variable-rate mortgages to be reduced, in particular if lenders lower their Prime to match the Bank of Canada.

 

Long Version

About 90% of the people receiving this email are current clients, and about 85% of those folks are currently in variable-rate mortgages. For these people, this recent rate cut was less shocking, as we have had ongoing discussions about what the Bank of Canada might do next.

At the end of 2014, Ozzie Jurock asked me for an interest rate prediction to print in the outstanding Annual Jurock Real Estate InsiderOutlook 2015‘ real estate report.

An excerpt: ‘During 2015, variable-rate mortgage holders will continue to rejoice. The Bank of Canada being as likely to increase Prime by 0.25% as they are to reduce Prime by 0.25%. Steady as she goes being the most likely outcome.’

Although Thomas Costerg gets the win for being the closest to call last week’s move. Clever fellow.

In the weeks leading up to the January 21 announcement, the incessant news reports warning of impending ‘rate shocks‘ (which continued up to and including a January 20 Vancouver Sun piece) were collectively so far disconnected from reality that on January 9 I posted a piece suggesting that indeed a ‘shocking‘ rate hike in 2015 was plausible, at least as plausible as a tornado lifting sharks from the ocean and dropping them on our city.

The irony of the CBC headline on January 21 was rich: Bank of Canada shocks markets with cut in key interest rate

Journalists do love that ‘S’ word so far in 2015.

OK, so the Bank of Canada cut rates. This is good news in some respects. But what does that actually mean for your mortgage?

As of January 24, 2015, mortgage lenders have not yet followed the rate reduction, nor are they contractually required to do. Mortgage lenders were smart enough to protect themselves from inadvertently offering a product (e.g., Prime minus X%) that could conceivably reach an effective rate of 0%.

Strictly speaking, mortgage lenders do not have to specifically follow the Bank of Canada rate movements. Instead, lenders set their own internal ‘Prime’ rate on which our mortgages and credit line rates are predicated.

This said, historically, lenders’ Prime has always moved in harmony with the Bank of Canada’s Prime. The exception was a similar 0.25% movement in December 2008, arguably a far more tumultuous time, with interest rates falling faster and further than ever before.

I expect to see this 0.25% reduction passed on to clients, perhaps with additional lag time of another week or two.

What is important to note (for those getting ready to purchase a home, or nearing mortgage renewal) is that, should lenders lower their Prime rate, there almost certainly there will be a simultaneous reduction of the current discount offered in variable rate mortgage products. Expect at least a corresponding 0.25% if not 0.50%.

Current variable-rate mortgage holders have only upside though. Their rates should either stay steady with a newfound buffer zone of 0.25% against a rebounding rate hike (unlikely for some time), or with a drop, which would be wonderful.

New mortgage seekers are not likely to see the same deep variable discounts on offer much longer, although they will still have access to net rates below 3% for some time to come.

What about fixed rates in all of this?

Fixed mortgage rates, although primarily dictated by the bond market, have been gradually edging lower since January 5, (arguably since 2008). January 21, 2015 saw a record low of .083% in the bond market with rates still not showing signs of recovery.

This means larger profit margins for lenders, as movement downward on longer-term fixed-rate products is lagging the movement in the bond market notably. Expect another quarter of record Bank earnings ahead. I have said it before: if you play the stock market, Buy Bank Stocks!

The downward pressure on five-year fixed is significant though, with 2.79% and perhaps lower as soon as this coming Monday.

From a marketing perspective Canada is enjoying strong property values and continued impressive sales activity in most major markets leaving little motivation for mortgage lenders to reduce rates as a means to spur activity. As we grow accustomed to sub 3.00% rates, there seems little psychological benefit to be the first lender to offer 2.78% or lower as there was to hit 2.99%.

2.79% is great, and it will be talked about, but the excitement, buzz and perceptions around a move from 2.89% to 2.79% is nowhere near as significant as was the move from 3.09% to 2.99%.

Nonetheless, the fact remains that we are still in a period of historic lows, and despite all the drastically wrong media predictions of the first 20 days, we are likely to remain here for some time. So enjoy! Edge up your payments thereby reducing your effective amortisations, and stop reading hyperbolic newspaper headlines about what might happen. Instead embrace and take advantage of what is happening.

The bottom line with regard to the impact of all of this on the Real Estate Market in general is that the actual qualifying rate remains the same. Canadians do not currently qualify for any larger a mortgage today than they did the day before the Bank of Canada announcement. There is no additional purchasing power in the hands of the home buyer at this point.

Perhaps the band Jane’s Addiction said it best: ‘Nothing’s Shocking’.

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Thank you

Dustan Woodhouse

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